UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the quarterly period ended March 31, 2013
   

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the transition period from           to

 

Commission File No. 814-00735

 

KCAP Financial, Inc.

(Exact name of Registrant as specified in its charter)

 

Delaware   20-5951150

(State or other jurisdiction of

Incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

295 Madison Avenue, 6th Floor

New York, New York 10017

(Address of principal executive offices)

 

 

(212) 455-8300

(Registrant's telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o   Accelerated filer x
         
Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o No x

 

The number of outstanding shares of common stock of the registrant as of May 3, 2013 was 33,038,573.

  

 

 

 
 

 

TABLE OF CONTENTS

         
        Page
     
    Part I. Financial Information    
     
Item 1.   Financial Statements   1
     
    Balance Sheets as of March 31, 2013 (unaudited) and December 31, 2012   1
     
    Statements of Operations (unaudited) for the three months ended March 31, 2013 and 2012   2
     
    Statements of Changes in Net Assets (unaudited) for the three months ended March 31, 2013 and 2012   3
     
    Statements of Cash Flows (unaudited) for the three months ended March 31, 2013 and 2012   4
     
  Schedules of Investments as of March 31, 2013  (unaudited) and December 31, 2012   5
     
    Financial Highlights (unaudited) for the three months ended March 31, 2013 and 2012   23
     
    Notes to Financial Statements (unaudited)   24
     
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations   45
     
Item 3.   Quantitative and Qualitative Disclosures About Market Risk   63
     
Item 4.   Controls and Procedures   64
     
    Part II. Other Information    
     
Item 1.   Legal Proceedings   66
     
Item 1A.   Risk Factors   66
     
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds   66
     
Item 3.   Defaults Upon Senior Securities   66
     
Item 4.   Mine Safety Disclosures   66
     
Item 5.   Other Information   66
     
Item 6.   Exhibits   66
   
Signatures   67
           

 

 
 

  

KCAP FINANCIAL, INC. 

BALANCE SHEETS

 

   As of
March 31, 2013
   As of
December 31, 2012
 
   (unaudited)     
ASSETS    
Investments at fair value:    
Time deposits (cost: 2013 -  $0; 2012 - $1,942,834)  $   $1,942,834 
Money market account (cost: 2013 - $38,887,925; 2012 - $30,543,824)   38,887,925    30,543,824 
Debt securities (cost: 2013 - $172,602,565; 2012 - $134,377,151)   151,549,821    111,037,882 
CLO Fund securities managed by non-affiliates (cost: 2013 - $10,321,884; 2012 - $10,487,023)   3,193,376    3,725,924 
CLO Fund securities managed by affiliates (cost: 2013 - $79,783,663; 2012 - $79,659,387)   75,076,683    79,531,583 
Equity securities (cost: 2013 - $18,260,008; 2012 - $18,375,588)   7,839,699    8,020,716 
Asset manager affiliates (cost: 2013 - $83,198,191; 2012 - $83,161,529)   80,354,000    77,242,000 
Total Investments at fair value (cost: 2013 - $403,054,236; 2012 - $358,547,336)   356,901,504    312,044,763 
Cash   5,070,802    738,756 
Interest receivable   1,850,238    697,349 
Receivable for open trades   487,851     
Accounts receivable   3,226,672    2,210,869 
Other assets   3,650,894    3,568,736 
           
Total assets  $371,187,961   $319,260,473 
           
LIABILITIES          
Convertible senior notes  $60,000,000   $60,000,000 
Senior notes   41,400,000    41,400,000 
Payable for open trades   2,985,000     
Accounts payable and accrued expenses   930,636    2,581,432 
Dividend payable       7,403,382 
           
Total liabilities  $105,315,636   $111,384,814 
           
STOCKHOLDERS' EQUITY          
Common stock, par value $0.01 per share, 100,000,000 common shares authorized; 31,936,480 and 26,470,408 common shares issued and outstanding at March 31, 2013 and December 31, 2012, respectively  $319,043   $264,382 
Capital in excess of par value   361,299,553    310,566,503 
Accumulated undistributed net investment income   7,045,514    103,484 
Accumulated net realized losses   (56,118,312)   (56,035,375)
Net unrealized depreciation on investments   (46,673,473)   (47,023,335)
           
Total stockholders' equity  $265,872,325   $207,875,659 
           
Total liabilities and stockholders' equity  $371,187,961   $319,260,473 
           
NET ASSET VALUE PER COMMON SHARE  $8.33   $7.85 

 

See accompanying notes to financial statements.

 

1
 

 

KCAP FINANCIAL, INC.
STATEMENTS OF OPERATIONS
(unaudited)

 

   Three Months Ended 
   March 31, 
   2013   2012 
         
Investment Income:          
Interest from investments in debt securities  $2,478,018   $2,501,613 
Interest from cash and time deposits   4,712    2,562 
Dividends from investments in CLO Fund securities managed by non-affiliates   423,875    419,165 
Dividends from investments in CLO Fund securities managed by affiliates   5,480,653    3,613,639 
Dividends from affiliate asset managers   3,000,000    825,000 
Capital structuring service fees   6,573    39,561 
           
     Total investment income   11,393,831    7,401,540 
           
Expenses:          
Interest and amortization of debt issuance costs   2,260,246    1,442,286 
Compensation   909,713    947,735 
Professional fees   642,328    916,660 
Insurance   128,717    129,603 
Administrative and other   506,471    325,975 
           
     Total expenses   4,447,475    3,762,259 
           
Net Investment Income   6,946,356    3,639,281 
Realized And Unrealized Gains (Losses) On Investments:          
Net realized gains (losses) from investment transactions   (82,937)   302,734 
Net change in unrealized appreciation (depreciation) on:          
     Debt securities   2,286,526    (1,082,695)
     Equity securities   (65,437)   680,986 
     CLO Fund securities managed by affiliates   (4,579,158)   2,366,876 
     CLO Fund securities managed by non-affiliates   (367,408)   (26,843)
     Affiliate asset manager investments   3,075,339    (5,303,682)
           
     Total net change in unrealized appreciation (depreciation)   349,862    (3,365,358)
           
Net realized and unrealized appreciation (depreciation) on investments   266,925    (3,062,624)
           
Net Increase In Net Assets Resulting From Operations  $7,213,281   $576,657 
           
Net Increase In Net Assets Resulting from Operations per Common Share:          
     Basic:  $0.25   $0.02 
     Diluted:  $0.24   $0.02 
Net Investment Income Per Common Share:          
     Basic:  $0.24   $0.15 
     Diluted:  $0.23   $0.15 
           
Weighted Average Shares of Common Stock Outstanding—Basic   29,266,186    24,270,825 
Weighted Average Shares of Common Stock Outstanding—Diluted   36,635,703    24,270,825 

 

See accompanying notes to financial statements.

 

2
 

 

KCAP FINANCIAL, INC.
STATEMENTS OF CHANGES IN NET ASSETS
(unaudited)

 

 
   Three Months Ended
March 31,
 
   2013   2012 
         
Operations:          
Net investment income  $6,946,356   $3,639,281 
Net realized gains (losses) from investment transactions   (82,937)   302,734 
Net change in unrealized appreciation (depreciation) on investments   349,862    (3,365,358)
           
Net increase in net assets resulting from operations   7,213,281    576,657 
           
Stockholder distributions:          
Dividends to stockholders   (4,326)   (3,654)
           
Net decrease in net assets resulting from stockholder distributions   (4,326)   (3,654)
           
Capital transactions:          
Issuance of common stock for:          
Interest in affiliate asset manager       25,560,000 
Dividend reinvestment plan   237,606    122,843 
Issuance of common stock for public offering   50,632,166     
Offering costs of public share offering   (102,423)    
Stock based compensation   20,362    172,729 
           
Net increase in net assets resulting from capital transactions   50,787,711    25,855,572 
           
Net assets at beginning of period   207,875,659    180,525,941 
           
Net assets at end of period (including undistributed net investment income of $7,045,514 in 2013 and $4,457,530 in 2012)  $265,872,325   $206,954,516 
           
Net asset value per common share  $8.33   $7.78 
Common shares outstanding at end of period   31,936,480    26,609,963 

 

See accompanying notes to financial statements.

 

3
 

 

KCAP FINANCIAL, INC.
STATEMENTS OF CASH FLOWS
(unaudited)

 

   Three Months Ended
March 31,
 
   2013   2012 
         
OPERATING ACTIVITIES:          
Net increase in net assets resulting from operations  $7,213,281   $576,657 
Adjustments to reconcile net increase in net assets resulting from operations to net cash provided by (used in) operations:          
   Net realized (gains) losses on investment transactions   82,937    (302,734)
   Net change in unrealized (appreciation) depreciation on investments   (349,862)   3,365,358 
   Net accretion of discount on securities and loans   (176,559)   (680,795)
   Amortization of debt issuance cost   184,435    118,020 
   Stock-based compensation expense   20,362    172,729 
Changes in operating assets and liabilities:          
   Purchases of investments   (48,671,615)   (36,317,935)
   Proceeds from sale and redemption of investments   4,812,673    39,032,930 
   Increase in interest and dividends receivable   (1,152,889)   (211,593)
   Increase in accounts receivable   (1,015,803)   (92,419)
   Decrease in time deposit   1,942,834     
   Increase in other assets   (266,595)   (323,790)
   Decrease in accounts payable and accrued expenses   (1,650,794)   (1,800,648)
           
               Net cash provided by (used in) operating activities   (39,027,595)   3,535,780 
           
FINANCING ACTIVITIES:          
Proceeds from issuance of common stock   50,632,166     
Offering costs of public share offering   (102,423)    
Dividends paid in cash   (7,170,102)   (3,960,849)
Increase in restricted cash       (98,068)
           
               Net cash provided by (used in) financing activities   43,359,641    (4,058,917)
           
CHANGE IN CASH   4,332,046    (523,137)
CASH, BEGINNING OF PERIOD   738,756    2,555,259 
           
CASH, END OF PERIOD  $5,070,802   $2,032,122 
           
Supplemental Information:          
Interest paid during the period  $3,388,313   $2,625,000 
Dividends paid during the period under the dividend reinvestment plan  $237,606   $122,844 
Issuance of common stock in connection with acquisition of affiliate asset manager  $   $25,560,000 

 

See accompanying notes to financial statements.

 

4
 

 

KCAP FINANCIAL, INC.
SCHEDULE OF INVESTMENTS

As of March 31, 2013

 

(Unaudited)

 

Debt Securities Portfolio                         
             
Portfolio Company / Principal Business  

Investment

Interest Rate¹ / Maturity

  Principal   Cost   Value2

Advanced Lighting Technologies, Inc.10

Home and Office Furnishings, Housewares, and Durable Consumer Products

 

First Lien Bond — Bond

10.5% Cash, Due 6/19

  $ 3,000,000   $ 2,930,343   $ 3,000,000
             

Alaska Communications Systems Holdings, Inc. 10

Telecommunications

 

Senior Secured Loan — Term Loan

5.5% Cash, Due 10/16

    2,927,557     2,939,341     2,878,667
                         

Allison Transmission, Inc.

Automobile

 

Senior Secured Loan — New Term B-2 Loan

3.2% Cash, Due 8/17

    1,975,050     1,963,112     1,996,381
             

Aramark Corporation10

Diversified/Conglomerate Service

 

Senior Secured Loan — LC-3 Facility

3.8% Cash, Due 7/16

    61,707     61,588     62,207
                         

Aramark Corporation10

Diversified/Conglomerate Service

 

Senior Secured Loan — U.S. Term C Loan

3.8% Cash, Due 7/16

    938,293     936,481     945,893
             

Asurion, LLC (fka Asurion Corporation)10

Insurance

 

Senior Secured Loan — Incremental Tranche B-1 Term Loan

4.5% Cash, Due 5/19

    1,995,000     2,017,060     2,019,738
                         

Avis Budget Car Rental, LLC

Personal Transportation

 

Senior Secured Loan — New Tranche B Term Loan

3.8% Cash, Due 3/19

    1,985,007     2,015,824     2,011,209
             

Bankruptcy Management Solutions, Inc.10

Diversified/Conglomerate Service

 

Junior Secured Loan — Loan (Second Lien)

1.2% Cash, 7.0% PIK, Due 8/15

    1,430,488     1,225,488     50,067
                         

Bankruptcy Management Solutions, Inc.10

Diversified/Conglomerate Service

 

Senior Secured Loan — Term Loan B

6.5% Cash, 1.0% PIK, Due 8/14

    1,439,045     1,401,761     953,367
           .

BBB Industries, LLC10

Automobile

 

Senior Secured Loan — Term Loan B

5.5% Cash, Due 3/19

    3,000,000     2,985,000     3,000,000

 

 

5
 

 

Portfolio Company / Principal Business  

Investment

Interest Rate¹ / Maturity

  Principal   Cost   Value2

Berry Plastics Corporation

Containers, Packaging and Glass

 

Senior Secured Loan — Term C Loan

2.2% Cash, Due 4/15

  $ 1,973,753   $ 1,947,316   $ 1,984,609
             

Burger King Corporation

Personal, Food and Miscellaneous Services

 

Senior Secured Loan — Tranche B Term Loan (2012)

3.8% Cash, Due 9/19

    1,641,750     1,637,926     1,664,899
                         

Caribe Media Inc. (fka Caribe Information Investments Incorporated)10

Printing and Publishing

 

Senior Secured Loan — Loan

10.0% Cash, Due 11/14

    590,817     590,817     578,706
             

Catalina Marketing Corporation10

Diversified/Conglomerate Service

 

Senior Secured Loan — 2017 Term Loan

5.7% Cash, Due 9/17

    1,704,212     1,673,889     1,716,142
                         

Chrysler Group LLC10

Automobile

 

Senior Secured Loan — Tranche B Term Loan

6.0% Cash, Due 5/17

    1,974,874     1,974,874     2,014,569
             

Clover Technologies Group, LLC (Clover Holdings Inc.)10

Personal and Non Durable Consumer Products (Mfg. Only)

 

Senior Secured Loan — Term Loan

6.8% Cash, Due 5/18

    3,000,000     3,043,808     3,000,000
                         

CoActive Technologies LLC (fka CoActive Technologies, Inc.)8, 10

Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

  Junior Secured Loan — Term Loan (Second Lien) 7.1% PIK, Due 1/15     2,063,007     1,987,358     1,403,876
             

Del Monte Foods Company10

Beverage, Food and Tobacco

 

Senior Secured Loan — Initial Term Loan

4.0% Cash, Due 3/18

    946,751     948,443     956,881
                         

Del Monte Foods Company10

Beverage, Food and Tobacco

 

Senior Secured Loan — Initial Term Loan

4.0% Cash, Due 3/18

    1,922,336     1,903,389     1,942,905
             

eInstruction Corporation8, 10

Healthcare, Education and Childcare

 

Junior Secured Loan — Term Loan (Second Lien)

11.5% Cash, Due 7/14

    10,000,000     10,000,000     1,000
                         

ELO Touch Solutions, Inc.10

Electronics

 

Senior Secured Loan — Term Loan (First Lien)

8.0% Cash, Due 6/18

    1,985,000     1,914,025     1,976,266
             

First American Payment Systems, L.P.10

Finance

 

Junior Secured Loan — Term Loan (Second Lien)

10.8% Cash, Due 4/19

    3,000,000     2,944,206     3,002,400

 

6
 

 

Portfolio Company / Principal Business  

Investment

Interest Rate¹ / Maturity

  Principal   Cost   Value2

First Data Corporation10

Finance

 

Senior Secured Loan — 2018 Dollar Term Loan

4.2% Cash, Due 3/18

  $ 2,000,000   $ 1,815,958   $ 1,996,600
             

Flexera Software LLC (fka Flexera Software, Inc.)10

Electronics

 

Senior Secured Loan — Term Loan

6.0% Cash, Due 3/19

    1,750,000     1,741,306     1,766,625
                         

Fram Group Holdings Inc./Prestone Holdings Inc.10

Automobile

 

Senior Secured Loan — Term Loan (First Lien)

6.5% Cash, Due 7/17

    966,900     972,915     981,791
             

Freescale Semiconductor, Inc.

Electronics

 

Senior Subordinated Bond — Bond

10.3% Cash, Due 12/16

    1,036,000     1,037,854     1,060,657
                         

Getty Images, Inc.10

Printing and Publishing

 

Senior Secured Loan — Initial Term Loan (New)

4.8% Cash, Due 10/19

    1,995,000     1,976,309     2,025,125
             

Ginn LA Conduit Lender, Inc.8, 10

Buildings and Real Estate4

 

Junior Secured Loan — Loan (Second Lien)

7.8% Cash, Due 6/12

    3,000,000     2,715,997     30,000
                         

Ginn LA Conduit Lender, Inc.8, 10

Buildings and Real Estate4

 

Senior Secured Loan — First Lien Tranche B Term Loan

11.8% Cash, Due 6/11

    2,694,857     2,624,028     94,320
             

Ginn LA Conduit Lender, Inc.8, 10

Buildings and Real Estate4

 

Senior Secured Loan — First Lien Tranche A Credit-Linked Deposit

7.8% Cash, Due 6/11

    1,257,143     1,224,101     44,000
                         

Grupo HIMA San Pablo, Inc.10

Healthcare, Education and Childcare

 

Senior Secured Loan — Term B Loan (First Lien)

8.5% Cash, Due 1/18

    3,000,000     2,941,940     2,940,000
             

Grupo HIMA San Pablo, Inc.10

Healthcare, Education and Childcare

 

Junior Secured Loan — Term Loan (Second Lien)

13.8% Cash, Due 7/18

    5,000,000     4,757,353     4,750,000
                         

Gymboree Corporation., The10

Retail Stores

 

Senior Secured Loan — Term Loan

5.0% Cash, Due 2/18

    1,421,105     1,359,024     1,380,746
             

HMSC Corporation (aka Swett and Crawford)10

Insurance

 

Junior Secured Loan — Loan (Second Lien)

5.7% Cash, Due 10/14

    5,000,000     4,956,001     5,000,000

 

 

7
 

 

Portfolio Company / Principal Business  

Investment

Interest Rate¹ / Maturity

  Principal   Cost   Value2

Hunter Defense Technologies, Inc.10

Aerospace and Defense

 

Junior Secured Loan — Term Loan (Second Lien)

7.0% Cash, Due 2/15

  $ 4,074,074   $ 4,033,245   $ 3,829,630
             

Iasis Healthcare LLC10

Healthcare, Education and Childcare

 

Senior Unsecured Bond — Bond

8.4% Cash, Due 5/19

    3,000,000     2,881,315     3,168,900
                         

International Architectural Products, Inc.8, 10

Mining, Steel, Iron and Non-Precious Metals

 

Senior Secured Loan — Term Loan

12.0% Cash, Due 5/15

    507,431     480,867     263,862
             

Jones Stephens Corp.10

Home and Office Furnishings, Housewares, and Durable Consumer Products

 

Senior Secured Loan — Term Loan

7.0% Cash, Due 9/15

    4,245,064     4,245,064     4,245,064
                         

KIK Custom Products Inc.10

Personal and Non Durable Consumer Products (Mfg. Only)

 

Junior Secured Loan — Loan (Second Lien)

5.2% Cash, Due 12/14

    5,000,000     5,000,000     4,416,500
             

LBREP/L-Suncal Master I LLC8, 10

Buildings and Real Estate4

 

Senior Secured Loan — Term Loan (First Lien)

7.5% Cash, Due 1/10

    3,345,759     3,345,759     303,460
                         

Lord & Taylor Holdings LLC (LT Propco LLC)10

Retail Stores

 

Senior Secured Loan — Term Loan

5.8% Cash, Due 1/19

    430,951     439,798     435,950
             

Michael Foods Group, Inc. (f/k/a M-Foods Holdings, Inc.)10

Beverage, Food and Tobacco

 

Senior Secured Loan — Term B Facility

4.3% Cash, Due 2/18

    1,801,784     1,804,568     1,831,153
                         

Neiman Marcus Group Inc., The10

Retail Stores

 

Senior Secured Loan — Term Loan

4.0% Cash, Due 5/18

    2,000,000     1,986,541     2,021,000
             

Pegasus Solutions, Inc.10

Leisure, Amusement, Motion Pictures, Entertainment

 

Senior Subordinated Bond — Senior Subordinated Second Lien PIK Notes

13.0% PIK, Due 4/14

    1,691,007     1,691,007     1,688,977
                         

Perseus Holding Corp.10

Leisure, Amusement, Motion Pictures, Entertainment

 

Preferred Stock — Preferred Stock

14.0% PIK, Due 4/14

    400,000     400,000     373,880
             

PetCo Animal Supplies, Inc.10

Retail Stores

 

Senior Secured Loan — New Loans

4.0% Cash, Due 11/17

    1,994,898     1,994,898     2,025,220

 

 

8
 

 

Portfolio Company / Principal Business  

Investment

Interest Rate¹ / Maturity

  Principal   Cost   Value2

Pinnacle Foods Finance LLC

Beverage, Food and Tobacco

 

Senior Secured Loan — Extended Initial Term Loan

3.7% Cash, Due 10/16

  292,276   $  292,276   $  295,199
             

Pinnacle Foods Finance LLC

Beverage, Food and Tobacco

 

Senior Secured Loan — Extended Initial Term Loan

3.7% Cash, Due 10/16

    1,984,962     1,983,733     2,004,812
                         

SGF Produce Holding Corp.(Frozsun, Inc.)10

Beverage, Food and Tobacco

 

Senior Secured Loan — Term Loan

6.0% Cash, , Due 3/19

    5,000,000     4,950,251     4,950,000
             

TPF Generation Holdings, LLC10

Utilities

 

Senior Secured Loan — Synthetic LC Deposit (First Lien)

2.3% Cash, Due 12/13

    169,532     169,345     169,532
                         

Trimaran Advisors, L.L.C.10

Finance

 

Senior Unsecured Loan — Revolving Credit Facility

9.0% Cash, Due 11/17

    20,000,000     20,000,000     20,000,000
             

TriZetto Group, Inc. (TZ Merger Sub, Inc.)10

Electronics

 

Senior Secured Loan — Term Loan

4.8% Cash, Due 5/18

    1,954,886     1,946,534     1,968,570
                         

TRSO I, Inc.10

Oil and Gas

 

Junior Secured Loan — Term Loan (Second Lien)

11.0% Cash, Due 12/17

    10,400,000     10,203,182     10,400,000
             

TUI University, LLC10

Healthcare, Education and Childcare

 

Senior Secured Loan — Term Loan (First Lien)

7.3% Cash, Due 10/14

    2,051,442     2,028,110     1,796,858
                         

TWCC Holding Corp.10

Broadcasting and Entertainment

 

Senior Secured Loan — Term Loan

3.5% Cash, Due 2/17

    1,966,350     1,980,643     1,996,239
             

Univar Inc.10

Chemicals, Plastics and Rubber

 

Senior Secured Loan — Term B Loan

5.0% Cash, Due 6/17

    2,947,249     2,947,249     2,981,437
                         

US Foods, Inc. (aka U.S. Foodservice, Inc.)10

Personal, Food and Miscellaneous Services

 

Senior Secured Loan — Extended Term Loan

5.8% Cash, Due 3/17

  1,972,275   1,929,303   2,000,281
             

Vertafore, Inc.10

Electronics

 

Senior Secured Loan — Term Loan (First Lien)

5.3% Cash, Due 7/16

    1,234,227     1,230,137     1,249,655

 

9
 

 

Portfolio Company / Principal Business  

Investment

Interest Rate¹ / Maturity

  Principal   Cost   Value2

Vestcom International, Inc. (fka Vector Investment Holdings, Inc.)10

Printing and Publishing

 

Senior Secured Loan — Term Loan

7.0% Cash, Due 12/18

    3,000,000     2,941,643     3,001,800
             

Wholesome Sweeteners, Inc.10

Beverage, Food and Tobacco

 

Junior Secured Loan — Subordinated Note (Second Lien)

14.0% Cash, Due 10/17

    6,648,596     6,608,069     6,648,596
                         

WireCo WorldGroup Inc. 10

Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

 

Senior Unsecured Bond — Bond

11.8% Cash, Due 5/17

    8,000,000     7,924,193     8,253,600
                       

Total Investment in Debt Securities

(57% of net asset value at fair value)

  $ 174,788,415   $ 172,602,565   $ 151,549,821

 

 

Equity Securities Portfolio                       
                         
Portfolio Company / Principal Business   Investment  

Percentage

Interest/Shares

  Cost   Value2

Aerostructures Holdings L.P.6, 10

Aerospace and Defense

  Partnership Interests     1.2%   $ 1,000,000   $ 1,000
             

Aerostructures Holdings L.P.6, 10

Aerospace and Defense

  Series A Preferred Interests     1.2%     250,961     50,511
                         

Bankruptcy Management Solutions, Inc.6, 10

Diversified/Conglomerate Service

  Common Stock     1.2%     218,592     1,000
             

Bankruptcy Management Solutions, Inc.6, 10

Diversified/Conglomerate Service

  Warrants     0.1%     -     -
                         

Coastal Concrete Holding II, LLC6, 10

Buildings and Real Estate4

  Class A Units     10.8%     8,625,626     1,000
                   

eInstruction Acquisition, LLC6, 10

Healthcare, Education and Childcare

  Membership Units     1.1%     1,079,617     1,000
                         

FP WRCA Coinvestment Fund VII, Ltd.3, 6,

Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

  Class A Shares      1,500     1,500,000     1,725,702

 

10
 

 

Portfolio Company / Principal Business   Investment  

Percentage

Interest/Shares

  Cost   Value2

International Architectural Products, Inc.6, 10

Mining, Steel, Iron and Non-Precious Metals

  Common Stock     2.5%     292,851     1,000
                         

Perseus Holding Corp.3, 6, 10

Leisure, Amusement, Motion Pictures, Entertainment

  Common Stock     0.2%     400,000     13,961
             

Plumbing Holdings Corporation6, 10

Home and Office Furnishings, Housewares, and Durable Consumer Products

  Common Stock     7.8%     -     532,191
                         

Plumbing Holdings Corporation6, 10

Home and Office Furnishings, Housewares, and Durable Consumer Products

  Preferred Stock     15.5%     3,032,596     3,311,853
                       

Caribe Media Inc. (fka Caribe Information Investments Incorporated)6, 10

Printing and Publishing

  Common Stock     1.3%   $ 359,765   $ 635,199
                         

TRSO II, Inc.6, 10

Oil and Gas

  Common Stock     5.4%     1,500,000     1,565,282
             

Total Investment in Equity Securities

(3% of net asset value at fair value)

            $ 18,260,008   $ 7,839,699

 

 

11
 

 

CLO Fund Securities

 

CLO Equity Investments

 

Portfolio Company   Investment  

Percentage

Interest

  Cost   Value2
Grant Grove CLO, Ltd.3   Subordinated Securities     22.2%   $ 4,898,554   $ 2,742,376
Katonah III, Ltd.3, 11   Preferred Shares     23.1%     2,103,330     450,000
Katonah V, Ltd.3, 11   Preferred Shares     16.4%     3,320,000     1,000
Katonah VII CLO Ltd.3, 7   Subordinated Securities     10.3%     4,542,611     2,090,033
Katonah VIII CLO Ltd3, 7   Subordinated Securities     6.9%     3,426,105     1,894,796
Katonah IX CLO Ltd3, 7   Preferred Shares     26.7%     2,078,487     1,337,570
Katonah X CLO Ltd 3, 7   Subordinated Securities     33.3%     11,857,236     8,178,887
Katonah 2007-I CLO Ltd.3, 7   Preferred Shares     100.0%     31,018,671     28,987,453
Trimaran CLO IV, Ltd.3, 7   Preferred Shares     19.0%     3,590,600     3,097,265
Trimaran CLO V, Ltd.3, 7   Subordinate Notes     20.8%     2,746,300     2,603,141
Trimaran CLO VI, Ltd.3, 7   Income Notes     16.2%     2,856,100     2,653,887
Trimaran CLO VII, Ltd.3, 7   Income Notes     10.5%     3,143,300     3,015,851
Catamaran CLO 2012-1 Ltd.3, 7   Subordinated Notes     24.9%     9,397,900     7,777,800
                         
Total Investment in CLO Equity Securities             $ 84,979,194   $ 64,830,059

 

 

CLO Rated-Note Investments

 

Portfolio Company   Investment  

Percentage

Interest

  Cost   Value2
Katonah 2007-I CLO Ltd.3, 7  

Class B-2L Notes

Par Value of $10,500,000

5.3%, Due 4/22

    100.0%   $ 1,258,651   $ 9,440,000
Catamaran CLO 2012-1 Ltd.3, 7  

Class F Notes

Par Value of $4,500,000

6.8%, Due 12/23

    42.9%     3,867,702     4,000,000
                         
Total Investment in CLO Rated-Notes             $ 5,126,353   $ 13,440,000
                       

Total Investment in CLO Fund Securities

(29% of net asset value at fair value)

            $ 90,105,547   $ 78,270,059

 

 

Asset Manager Affiliates

 

Portfolio Company / Principal Business   Investment  

Percentage

Interest

  Cost   Value2
Asset Manager Affiliates10   Asset Management Company     100.0%   $ 83,198,191   $ 80,354,000
                       

Total Investment in Asset Manager Affiliates

(30% of net asset value at fair value)

            $ 83,198,191   $ 80,354,000

 

 

12
 

 

Money Market Account

 

Money Market Accounts   Investment   Yield   Par / Cost   Value2
                         
JP Morgan Business Money Market Account9, 10   Money Market Account     0.15%     245,821     245,821
             
US Bank Money Market Account10   Money Market Account     0.40%     38,642,104     38,642,104
                         

Total Investment in Money Market Accounts

(15% of net asset value at fair value)

            $ 38,887,925   $ 38,887,925
                       

Total Investments5

(134% of net asset value at fair value)

            $ 403,054,236   $ 356,901,504

 

See accompanying notes to financial statements.

 

1

 

A majority of the variable rate loans to the Company’s portfolio companies bear interest at a rate that may be determined by reference to either LIBOR or an alternate Base Rate (commonly based on the Federal Funds Rate or the Prime Rate), which typically resets semi-annually, quarterly, or monthly. For each such loan, the Company has provided the weighted average annual stated interest rate in effect at March 31, 2013.
   
2 Reflects the fair market value of all investments as of March 31, 2013, as determined by the Company’s Board of Directors.
   
3 Non-U.S. company or principal place of business outside the U.S.
   
4 Buildings and real estate relate to real estate ownership, builders, managers and developers.
   
5 The aggregate cost of investments for federal income tax purposes is approximately $403 million. The aggregate gross unrealized appreciation is approximately $12 million, the aggregate gross unrealized depreciation is approximately $58 million, and the net unrealized depreciation is approximately $46 million.
   
6 Non-income producing.
   
7 An affiliate CLO Fund managed by an Asset Manager Affiliate (as such term is defined in the notes to the financial statements).
   
8 Loan or debt security is on non-accrual status and therefore is considered non-income producing.
   
9 Money market account holding restricted cash and security deposits for employee flexible spending and payroll related accounts.
   
10 Qualified asset for purposes of section 55(a) of the Investment Company Act of 1940.
   
11 As of March 31, 2013, this CLO Fund Security was not providing a dividend distribution.

 

13
 

 

KCAP FINANCIAL, INC.
SCHEDULE OF INVESTMENTS

As of December 31, 2012 

 

Debt Securities Portfolio

 

Portfolio Company / Principal Business  

Investment

Interest Rate¹ / Maturity

  Principal   Cost   Value2

Advanced Lighting Technologies, Inc.10

Home and Office Furnishings, Housewares, and Durable Consumer Products

 

First Lien Bond — Bond

10.5% Cash, Due 6/19

  $ 3,000,000   $ 2,928,762   $ 3,000,000
             

Alaska Communications Systems Holdings, Inc. 10

Telecommunications

 

Senior Secured Loan — Term Loan

5.5% Cash, Due 10/16

    2,940,000     2,952,655     2,783,196
                         

Allison Transmission, Inc.

Automobile

 

Senior Secured Loan — Term B-2 Loan

3.7% Cash, Due 8/17

    1,980,000     1,969,312     1,995,672
             

Aramark Corporation10

Diversified/Conglomerate Service

 

Senior Secured Loan — LC-3 Facility

3.5% Cash, Due 7/16

    61,707     61,579     61,910
                         

Aramark Corporation10

Diversified/Conglomerate Service

 

Senior Secured Loan — U.S. Term C Loan

3.5% Cash, Due 7/16

    938,293     936,347     941,390
             

Asurion, LLC (fka Asurion Corporation)10

Insurance

 

Senior Secured Loan — Term Loan (First Lien)

5.5% Cash, Due 5/18

    2,000,000     2,021,506     2,023,130
                         

Avis Budget Car Rental, LLC

Personal Transportation

 

Senior Secured Loan — Tranche C Term Loan

4.3% Cash, Due 3/19

    1,985,007     2,012,685     2,005,353
             

Bankruptcy Management Solutions, Inc.10

Diversified/Conglomerate Service

 

Junior Secured Loan — Loan (Second Lien)

1.2% Cash, 7.0% PIK, Due 8/15

    1,405,472     1,225,488     47,435
                         

Bankruptcy Management Solutions, Inc.10

Diversified/Conglomerate Service

 

Senior Secured Loan — Term Loan B

6.5% Cash, 1.0% PIK, Due 8/14

    1,439,164     1,405,984     773,551
           .

Berry Plastics Holding Corporation

Containers, Packaging and Glass

 

Senior Secured Loan — Term C Loan

2.2% Cash, Due 4/15

    1,979,003     1,949,236     1,971,898

 

 

14
 

 

Portfolio Company / Principal Business  

Investment

Interest Rate¹ / Maturity

  Principal   Cost   Value2

Burger King Corporation

Personal, Food and Miscellaneous Services

 

Senior Secured Loan — Tranche B Term Loan (2012)

3.8% Cash, Due 9/19

  $ 1,645,875   $ 1,641,896   $ 1,657,297
             

Caribe Media Inc. (fka Caribe Information Investments Incorporated)10

Printing and Publishing

 

Senior Secured Loan — Loan

10.0% Cash, Due 11/14

    621,074     621,074     613,373
                         

Catalina Marketing Corporation10

Diversified/Conglomerate Service

 

Senior Secured Loan — 2017 Term Loan

5.7% Cash, Due 9/17

    1,704,212     1,672,227     1,711,140
             

Chrysler Group LLC10

Automobile

 

Senior Secured Loan — Tranche B Term Loan

6.0% Cash, Due 5/17

    1,979,899     1,979,899     2,024,724
                         

CoActive Technologies LLC (fka CoActive Technologies, Inc.)8, 10

Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

 

Junior Secured Loan — Term Loan (Second Lien)

2.3% Cash, 4.8% PIK, Due 1/15

    2,063,007     1,987,358     1,299,695
             

Del Monte Foods Company10

Beverage, Food and Tobacco

 

Senior Secured Loan — Initial Term Loan

4.5% Cash, Due 3/18

    949,124     950,905     952,237
                         

Del Monte Foods Company10

Beverage, Food and Tobacco

 

Senior Secured Loan — Initial Term Loan

4.5% Cash, Due 3/18

    1,927,154     1,907,210     1,933,475
             

eInstruction Corporation8, 10

Healthcare, Education and Childcare

 

Junior Secured Loan — Term Loan (Second Lien)

11.5% Cash, Due 7/14

    10,000,000     10,000,000     1,000
                         

ELO Touch Solutions, Inc.10

Electronics

 

Senior Secured Loan — Term Loan (First Lien)

8.0% Cash, Due 6/18

    1,990,000     1,915,453     1,989,603
             

First American Payment Systems, L.P.10

Finance

 

Junior Secured Loan — Term Loan (Second Lien 2012)

10.8% Cash, Due 4/19

    3,000,000     2,941,926     2,985,000
                         

First Data Corporation10

Finance

 

Senior Secured Loan — 2018 Dollar Term Loan

4.2% Cash, Due 3/18

    2,000,000     1,806,842     1,906,710
             

Fram Group Holdings Inc./Prestone Holdings Inc.10

Automobile

 

Senior Secured Loan — Term Loan (First Lien)

6.5% Cash, Due 7/17

    989,975     996,484     991,212

 

 

15
 

 

Portfolio Company / Principal Business  

Investment

Interest Rate¹ / Maturity

  Principal   Cost   Value2

Freescale Semiconductor, Inc.

Electronics

 

Senior Subordinated Bond — Bond

10.1% Cash, Due 12/16

  $ 1,036,000   $ 1,038,081   $ 1,064,490
             

Getty Images, Inc.10

Printing and Publishing

 

Senior Secured Loan — Initial Term Loan (New)

4.8% Cash, Due 10/19

    2,000,000     1,980,556     2,005,250
                         

Ginn LA Conduit Lender, Inc.8, 10

Buildings and Real Estate4

 

Senior Secured Loan — First Lien Tranche A Credit-Linked Deposit

7.8% Cash, Due 6/11

    1,257,143     1,224,101     38,506
             

Ginn LA Conduit Lender, Inc.8, 10

Buildings and Real Estate4

 

Senior Secured Loan — First Lien Tranche B Term Loan

7.8% Cash, Due 6/11

    2,694,857     2,624,028     82,543
                         

Ginn LA Conduit Lender, Inc.8, 10

Buildings and Real Estate4

 

Junior Secured Loan — Loan (Second Lien)

11.8% Cash, Due 6/12

    3,000,000     2,715,997     30,015
             

Gymboree Corporation., The10

Retail Stores

 

Senior Secured Loan — Term Loan

5.0% Cash, Due 2/18

    1,421,105     1,355,901     1,312,746
                         

HMSC Corporation (aka Swett and Crawford)10

Insurance

 

Junior Secured Loan — Loan (Second Lien)

5.7% Cash, Due 10/14

    5,000,000     4,948,801     4,410,000
             

Hunter Defense Technologies, Inc.10

Aerospace and Defense

 

Junior Secured Loan — Term Loan (Second Lien)

7.0% Cash, Due 2/15

    4,074,074     4,027,935     3,829,630
                         

Iasis Healthcare LLC10

Healthcare, Education and Childcare

 

Senior Unsecured Bond — Bond

8.4% Cash, Due 5/19

    3,000,000     2,877,729     2,865,000
             

International Architectural Products, Inc.8, 10

Mining, Steel, Iron and Non-Precious Metals

 

Senior Secured Loan — Term Loan

12.0% Cash, Due 5/15

    507,431     480,868     263,864
                         

Jones Stephens Corp.10

Home and Office Furnishings, Housewares, and Durable Consumer Products

 

Senior Secured Loan — Term Loan

7.0% Cash, Due 9/15

    4,280,147     4,280,147     4,280,147
             

KIK Custom Products Inc.10

Personal and Non Durable Consumer Products (Mfg. Only)

 

Junior Secured Loan — Loan (Second Lien)

5.3% Cash, Due 12/14

    5,000,000     5,000,000     3,977,100

 

 

16
 

 

Portfolio Company / Principal Business  

Investment

Interest Rate¹ / Maturity

  Principal   Cost   Value2

LBREP/L-Suncal Master I LLC8, 10

Buildings and Real Estate4

 

Senior Secured Loan — Term Loan (First Lien)

7.5% Cash, Due 1/10

  $ 3,345,759   $ 3,345,759   $ 303,460
             

Legacy Cabinets, Inc.10

Home and Office Furnishings, Housewares, and Durable Consumer Products

 

Senior Secured Loan — Term Loan

1.0% Cash, 6.3% PIK, Due 5/14

    524,571     463,380     447,040
                         

Lord & Taylor Holdings LLC (LT Propco LLC)10

Retail Stores

 

Senior Secured Loan — Term Loan

5.8% Cash, Due 1/19

    430,951     439,877     436,002
             

Merisant Company10

Beverage, Food and Tobacco

 

Senior Secured Loan — Loan

7.5% Cash, Due 1/14

    4,547,032     4,538,541     4,547,032
                         

Michael Foods Group, Inc. (f/k/a M-Foods Holdings, Inc.)10

Beverage, Food and Tobacco

 

Senior Secured Loan — Term B Facility

4.3% Cash, Due 2/18

    1,825,626     1,828,589     1,838,934
             

Neiman Marcus Group Inc., The10

Retail Stores

 

Senior Secured Loan — Term Loan

4.8% Cash, Due 5/18

    2,000,000     1,985,894     2,005,800
                         

Pegasus Solutions, Inc.10

Leisure, Amusement, Motion Pictures, Entertainment

 

Senior Subordinated Bond — Senior Subordinated Second Lien PIK Notes

13.0% PIK, Due 4/14

    1,691,007     1,691,007     1,671,391
             

Perseus Holding Corp.10

Leisure, Amusement, Motion Pictures, Entertainment

 

Preferred Stock — Preferred Stock

14.0% PIK, Due 4/14

    400,000     400,000     371,160
                         

PetCo Animal Supplies, Inc.10

Retail Stores

 

Senior Secured Loan — New Loan

4.5% Cash, Due 11/17

    2,000,000     2,000,000     2,018,220
             

Pinnacle Foods Finance LLC10

Beverage, Food and Tobacco

 

Senior Secured Loan — Extended Initial Term Loan

3.7% Cash, Due 10/16

    293,014     293,014     295,025
                         

Pinnacle Foods Finance LLC10

Beverage, Food and Tobacco

 

Senior Secured Loan — Extended Initial Term Loan

3.7% Cash, Due 10/16

    1,989,975     1,988,656     2,003,636
             

TPF Generation Holdings, LLC10

Utilities

 

Senior Secured Loan — Synthetic LC Deposit (First Lien)

2.3% Cash, Due 12/13

    169,532     169,280     169,956

 

 

17
 

 

Portfolio Company / Principal Business  

Investment

Interest Rate¹ / Maturity

  Principal   Cost   Value2

TriZetto Group, Inc. (TZ Merger Sub, Inc.)10

Electronics

 

Senior Secured Loan — Term Loan

4.8% Cash, Due 5/18

    1,959,860     1,951,082     1,948,013
             

TRSO I, Inc.10

Oil and Gas

 

Junior Secured Loan — Term Loan (Second Lien)

11.0% Cash, Due 12/17

    10,400,000     10,192,913     10,192,000
                         

TUI University, LLC10

Healthcare, Education and Childcare

 

Senior Secured Loan — Term Loan (First Lien)

7.3% Cash, , Due 10/14

    2,051,442     2,024,477     1,751,521
             

TWCC Holding Corp.10

Broadcasting and Entertainment

 

Senior Secured Loan — Term Loan

4.3% Cash, Due 2/17

    1,966,350     1,978,846     1,990,930
                         

Univar Inc.10

Chemicals, Plastics and Rubber

 

Senior Secured Loan — Term B Loan

5.0% Cash, Due 6/17

    2,954,773     2,954,773     2,950,577
             

US Foods, Inc. (aka U.S. Foodservice, Inc.)10

Personal, Food and Miscellaneous Services

 

Senior Secured Loan — Extended Term Loan

5.8% Cash, Due 3/17

    1,978,284     1,932,524     1,983,536
                         

Vertafore, Inc.10

Electronics

 

Senior Secured Loan — Term Loan (First Lien)

5.3% Cash, Due 7/16

    1,237,381     1,232,977     1,250,275
             

Wholesome Sweeteners, Inc.10

Beverage, Food and Tobacco

 

Junior Secured Loan — Subordinated Note (Second Lien)

14.0% Cash, Due 10/17

    6,648,596     6,605,857     6,715,082
                         

WireCo WorldGroup Inc. 10

Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

 

Senior Unsecured Bond — Bond

11.8% Cash, Due 5/17

    8,000,000     7,920,733     8,320,000
                       

Total Investment in Debt Securities

(53% of net asset value at fair value)

      $ 136,283,876   $ 134,377,151   $ 111,037,882

 

 

18
 

 

Equity Securities Portfolio

 

Portfolio Company / Principal Business   Investment  

Percentage

Interest/Shares

  Cost   Value2

Aerostructures Holdings L.P.6, 10

Aerospace and Defense

  Partnership Interests     1.2%   $ 1,000,000   $ 1,000
             

Aerostructures Holdings L.P.6, 10

Aerospace and Defense

  Series A Preferred Interests     1.2%     250,961     44,112
                         

Bankruptcy Management Solutions, Inc.6, 10

Diversified/Conglomerate Service

  Common Stock     1.2%     218,592     1,000
             

Bankruptcy Management Solutions, Inc.6, 10

Diversified/Conglomerate Service

  Warrants     0.1%     -     -
                         

Coastal Concrete Holding II, LLC6, 10

Buildings and Real Estate4

  Class A Units     10.8%     8,625,626     1,000
                   

eInstruction Acquisition, LLC6, 10

Healthcare, Education and Childcare

  Membership Units     1.1%     1,079,617     1,000
                         

FP WRCA Coinvestment Fund VII, Ltd.3, 6,

Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

  Class A Shares      1,500     1,500,000     1,961,550
                         

International Architectural Products, Inc.6, 10

Mining, Steel, Iron and Non-Precious Metals

  Common Stock     2.5%     292,851     1,000
                         

Legacy Cabinets, Inc.6, 10

Home and Office Furnishings, Housewares, and Durable Consumer Products

  Equity     4.0%     115,580     1,000
             

Perseus Holding Corp.6, 10

Leisure, Amusement, Motion Pictures, Entertainment

  Common Stock     0.2%     400,000     10,930
                         

Plumbing Holdings Corporation6, 10

Home and Office Furnishings, Housewares, and Durable Consumer Products

  Common Stock     7.8%     -     644,937

 

 

 

19
 

 

Portfolio Company / Principal Business   Investment  

Percentage

Interest/Shares

  Cost   Value2

Plumbing Holdings Corporation6, 10

Home and Office Furnishings, Housewares, and Durable Consumer Products

  Preferred Stock     9.0%   $ 3,032,596   $ 3,240,496
                         

Caribe Media Inc. (fka Caribe Information Investments Incorporated)6, 10

Printing and Publishing

  Common Stock     1.3%     359,765     612,691
                         

TRSO II, Inc.6, 10

Oil and Gas

  Common Stock     5.4%     1,500,000     1,500,000
                       

Total Investment in Equity Securities

(4% of net asset value at fair value)

            $ 18,375,588   $ 8,020,716

 

 

CLO Fund Securities

 

CLO Equity Investments

 

Portfolio Company   Investment  

Percentage

Interest

  Cost   Value2
Grant Grove CLO, Ltd.3   Subordinated Securities     22.2%   $ 4,925,009   $ 3,124,924
Katonah III, Ltd.3, 11   Preferred Shares     23.1%     2,242,014     600,000
Katonah V, Ltd.3, 11   Preferred Shares     26.7%     3,320,000     1,000
Katonah VII CLO Ltd.3, 7   Subordinated Securities     16.4%     4,574,393     2,120,168
Katonah VIII CLO Ltd3, 7   Subordinated Securities     10.3%     3,450,705     2,171,998
Katonah IX CLO Ltd3, 7   Preferred Shares     6.9%     2,082,987     1,488,895
Katonah X CLO Ltd 3, 7   Subordinated Securities     33.3%     11,934,600     9,455,511
Katonah 2007-I CLO Ltd.3, 7   Preferred Shares     100.0%     31,189,147     30,091,886
Trimaran CLO IV, Ltd.3, 7   Preferred Shares     19.0%     3,616,600     3,575,571
Trimaran CLO V, Ltd.3, 7   Subordinate Notes     20.8%     2,757,100     2,930,004
Trimaran CLO VI, Ltd.3, 7   Income Notes     16.2%     2,894,700     2,936,626
Trimaran CLO VII, Ltd.3, 7   Income Notes     10.5%     3,146,900     3,357,924
Catamaran CLO 2012-1 Ltd.3, 7   Subordinated Notes     24.9%     8,982,400     8,493,000
                         
Total Investment in CLO Equity Securities             $ 85,116,555   $ 70,347,507

 

20
 

 

CLO Rated-Note Investment

 

Portfolio Company   Investment  

Percentage

Interest

  Cost   Value2
Katonah 2007-I CLO Ltd.3, 7  

Class B-2L Notes

Par Value of $10,500,000

5.3%, Due 4/22

    100.0%   $ 1,252,191   $ 9,140,000
Catamaran CLO 2012-1 Ltd.3, 7  

Class F Notes

Par Value of $4,500,000

6.8%, Due 12/23

    42.9%     3,777,664     3,770,000
                         
Total Investment in CLO Rated-Note             $ 5,029,855   $ 12,910,000
                       

Total Investment in CLO Fund Securities

(40% of net asset value at fair value)

            $ 90,146,410   $ 83,257,507

 

 

Asset Manager Affiliates

 

Portfolio Company / Principal Business   Investment  

Percentage

Interest

  Cost   Value2
Asset Manager Affiliates10   Asset Management Company     100.0%   $ 83,161,529   $ 77,242,000
                         

Total Investment in Asset Manager Affiliates

(37% of net asset value at fair value)

            $ 83,161,529   $ 77,242,000

 

 

Time Deposits and Money Market Account

 

Time Deposit and Money Market Accounts   Investment   Yield   Par / Cost   Value2
JP Morgan Asset Account10   Time Deposit     0.01%   $ 1,942,834   $ 1,942,834
                         
JP Morgan Business Money Market Account9, 10   Money Market Account     0.15%     195,856     195,856
             
US Bank Money Market Account10   Money Market Account     0.40%     30,347,968     30,347,968
                         

Total Investment in Time Deposit and Money Market Accounts

(16% of net asset value at fair value)

             $ 32,486,658    $ 32,486,658
                       

Total Investments5

(150% of net asset value at fair value)

            $ 358,547,336   $ 312,044,763

 

 

See accompanying notes to financial statements.

 

21
 

 

1

 

A majority of the variable rate loans to the Company’s portfolio companies bear interest at a rate that may be determined by reference to either LIBOR or an alternate Base Rate (commonly based on the Federal Funds Rate or the Prime Rate), which typically resets semi-annually, quarterly, or monthly. For each such loan, the Company has provided the weighted average annual stated interest rate in effect at December 31, 2012.
   
2 Reflects the fair market value of all investments as of December 31, 2012, as determined by the Company’s Board of Directors.
   
3 Non-U.S. company or principal place of business outside the U.S.
   
4 Buildings and real estate relate to real estate ownership, builders, managers and developers.
   
5 The aggregate cost of investments for federal income tax purposes is approximately $359 million. The aggregate gross unrealized appreciation is approximately $11 million, the aggregate gross unrealized depreciation is approximately $58 million, and the net unrealized depreciation is approximately $47 million.
   
6 Non-income producing.
   
7 An affiliate CLO Fund managed by an Asset Manager Affiliate (as such term is defined in the notes to the financial statements).
   
8 Loan or debt security is on non-accrual status and therefore is considered non-income producing.
   
9 Money market account holding restricted cash and security deposits for employee flexible spending and payroll related accounts.
   
10 Qualified asset for purposes of section 55(a) of the Investment Company Act of 1940.
   
11 As of December 31, 2012, this CLO Fund Security was not providing a dividend distribution.

 

22
 

 

KCAP FINANCIAL, INC.

FINANCIAL HIGHLIGHTS

(unaudited)

 

 
   Three Months Ended
March 31,
 
   2013   2012 
         
Per Share Data:            
Net asset value, at beginning of period  $7.85   $7.85 
       Net investment income1   0.22    0.15 
       Net realized gain1   -    0.01 
       Net change in unrealized apreciation (depreciation) on investments1   0.01   (0.25)
            Net loss   0.21    (0.09)
       Issuance of common stock (not including dividend reinvestment plan)   0.24    - 
       Issuance of common stock under dividend reinvestment plan   0.01    0.01 
       Stock based compensation expense   -    0.01 
            Net increase in net assets relating to stock-based transactions   0.27    0.02 
           
Net asset value, end of period  $8.33   $7.78 
Total net asset value return2   2.9%   (0.9)%
           
Ratio/Supplemental Data:            
Per share market value at beginning of period  $9.19   $6.31 
Per share market value at end of period  $10.77   $6.91 
Total market return3   17.2%   9.5%
Shares outstanding at end of period   31,936,480    26,609,963 
Net assets at end of period  $265,872,325   $206,954,516 
Portfolio turnover rate4   1.6%   6.9%
Average debt outstanding  $101,400,000   $60,000,000 
Weighted average interest rate on borrowings   8.2%   8.8%
Asset coverage ratio   362%   445%
Ratio of net investment income to average net assets5   11.7%   7.5%
Ratio of total expenses to average net assets5   7.5%   7.8%
Ratio of interest expense to average net assets5   3.8%   3.0%
Ratio of non-interest expenses to average net assets5   3.7%   4.8%

 

 

 

1 Based on average number of common shares outstanding for the period.

 

2 Total net asset value return (not annualized) equals the change in the net asset value per share over the beginning of period net asset value per share plus dividends, divided by the beginning net asset value per share less proceeds from issuance of common shares.

 

3 Total market return (not annualized) equals the change in the ending market price over the beginning of period price per share plus dividends, divided by the beginning price.

 

4 Not annualized. Portfolio turnover rate equals the year-to-date sales and paydowns over the average of the invested assets at fair value.

 

5 Annualized

 

See accompanying notes to financial statements.

 

23
 

  

KCAP FINANCIAL, INC.

 

NOTES TO FINANCIAL STATEMENTS

(unaudited)

 

1. ORGANIZATION

 

KCAP Financial, Inc. (“KCAP” or the “Company”) is an internally managed, non-diversified closed-end investment company that is regulated as a business development company (“BDC”) under the Investment Company Act of 1940. The Company originates, structures, and invests in senior secured term loans, mezzanine debt and selected equity securities primarily in privately-held middle market companies. The Company defines the middle market as comprising companies with earnings before interest, taxes, depreciation and amortization (“EBITDA”), of $10 million to $50 million and/or total debt of $25 million to $150 million. The Company was formed as a Delaware limited liability company on August 8, 2006 and, prior to the issuance of shares of the Company’s common stock in its initial public offering (“IPO”), converted to a corporation incorporated in Delaware on December 11, 2006. Prior to its IPO, the Company did not have material operations. The Company’s IPO of 14,462,000 shares of common stock raised net proceeds of approximately $200 million. Prior to the IPO, the Company issued 3,484,333 shares to affiliates of Kohlberg & Co., L.L.C., a leading middle market private equity firm, in exchange for the contribution to the Company of their ownership interests in Katonah Debt Advisors, L.L.C., and related affiliates controlled by the Company (collectively, “Katonah Debt Advisors”) and in securities issued by collateralized loan obligation funds (“CLO Funds”) managed by Katonah Debt Advisors and two other asset managers.

 

On February 29, 2012, the Company purchased Trimaran Advisors, L.L.C. (“Trimaran Advisors”), a CLO manager similar to Katonah Debt Advisors with assets under management of approximately $1.5 billion, for total consideration of $13.0 million in cash and 3,600,000 shares of the Company’s common stock. Contemporaneously with the acquisition of Trimaran Advisors, the Company acquired from Trimaran Advisors equity interests in certain CLO Funds managed by Trimaran Advisors for an aggregate purchase price of $12.0 million in cash. As of March 31, 2013, Katonah Debt Advisors and Trimaran Advisors are the Company’s only wholly-owned portfolio companies (collectively, “Asset Manager Affiliates”) and have approximately $3.5 billion of par value assets under management. Asset Manager Affiliates are registered under the Investment Advisers Act of 1940 and are managed independently from the Company by separate management teams and investment committees.

 

The Company’s investment objective is to generate current income and capital appreciation from investments made in senior secured term loans, mezzanine debt and selected equity investments in privately-held middle market companies. The Company also expects to continue to receive distributions of recurring fee income and to generate capital appreciation from its investment in the asset management business of the Asset Manager Affiliates. The Asset Manager Affiliates manage CLO Funds which invest in broadly syndicated loans, high-yield bonds and other credit instruments.

 

While the Company’s primary investment focus is on making loans to, and selected equity investments in, privately-held middle market companies, the Company may also invest in other investments such as loans to larger, publicly-traded companies, high-yield bonds and distressed debt securities. The Company may also receive warrants or options to purchase common stock in connection with its debt investments. In addition, the Company may also invest in debt and equity securities issued by the CLO Funds managed by our Asset Manager Affiliates or by other asset managers.

 

The Company has elected to be treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). To qualify as a RIC, the Company must, among other things, meet certain source-of-income and asset diversification requirements. As a RIC, the Company generally will not have to pay corporate-level taxes on any income that it distributes in a timely manner to its stockholders.

 

2. SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The accompanying unaudited financial statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required for annual financial statements. The unaudited interim financial statements and notes thereto should be read in conjunction with the financial statements and notes thereto in the Company’s Form 10-K for the year ended December 31, 2012, as filed with the U.S. Securities and Exchange Commission (the “Commission” or the “SEC”).

 

24
 

 

The financial statements reflect all adjustments, both normal and recurring which, in the opinion of management, are necessary for the fair presentation of the Company’s results of operations and financial condition for the periods presented. Furthermore, the preparation of the financial statements requires management to make significant estimates and assumptions including the fair value of investments that do not have a readily available market value. Actual results could differ from those estimates, and the differences could be material. The results of operations for the interim periods presented are not necessarily indicative of the operating results to be expected for the full year.

 

In accordance with Article 6 of Regulation S-X under the Securities Act of 1933, as amended (the “Securities Act”) and the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the Company does not consolidate portfolio company investments, including those in which it has a controlling interest e.g., the Asset Manager Affiliates. The Asset Manager Affiliates are subject to Accounting Standards Codification Topic 810, “Consolidation” and although the Company cannot consolidate portfolio company investments, this guidance impacted the required disclosures relating to the Asset Manager Affiliates, as it requires the Asset Manager Affiliates to consolidate their managed CLO Funds. As a result of the consolidation of these CLOs into the Asset Manager Affiliates, the Asset Manager Affiliates qualify as a “significant subsidiary” and, as a result, the Company is required to include additional disclosures regarding the Asset Manager Affiliates in its filings with the SEC. The additional financial information regarding the Asset Manager Affiliates do not directly impact the financial position or results of operations of the Company.

 

In addition, Katonah 2007-I Ltd. qualifies as a “significant subsidiary” and is also required to provide additional disclosures. Katonah 2007-I CLO Ltd is exempted company incorporated in November 15, 2006 with limited liability under the laws of the Cayman Islands for the sole purpose of investing in broadly syndicated loans, high-yield bonds and other credit instruments. The Fund is what is commonly known as a collateralized loan obligation fund (“CLO Fund”). The additional disclosures regarding Katonah 2007-I Ltd. do not directly impact the financial position or results of operations of the Company.

 

The additional financial information regarding the Asset Manager Affiliates and Katonah 2007-I CLO Ltd. (“Katonah 2007-I CLO”) can be found in Note 5 – Asset Manager Affiliates, below.

 

Investments

 

Investment transactions are recorded on the applicable trade date. Realized gains or losses are determined using the specific identification method.

 

Valuation of Portfolio Investments. The Company’s Board of Directors is ultimately and solely responsible for making a good faith determination of the fair value of portfolio investments on a quarterly basis. Debt and equity securities for which market quotations are readily available are generally valued at such market quotations. Debt and equity securities that are not publicly traded or whose market price is not readily available are valued by the Board of Directors based on detailed analyses prepared by management, the Valuation Committee of the Board of Directors, and, in certain circumstances, third parties with valuation expertise. Valuations are conducted by management on 100% of the investment portfolio at the end of each quarter. The Company follows the provisions of ASC Fair Value Measurements and Disclosures (“Fair Value Measurements and Disclosures ”). This standard defines fair value, establishes a framework for measuring fair value, and expands disclosures about assets and liabilities measured at fair value. Fair Value Measurements and Disclosures defines “fair value” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Subsequent to the adoption of Fair Value Measurements and Disclosures, the FASB has issued various staff positions clarifying the initial standard as noted below.

 

The FASB issued guidance that clarified and required new disclosures about fair value measurements. The clarifications and requirement to disclose the amounts and reasons for significant transfers between Level I and Level II, as well as significant transfers in and out of Level III of the fair value hierarchy. Note 4 below reflects the amended disclosure requirements. The new guidance also required that purchases, sales, issuances and settlements be presented gross in the Level III reconciliation and that requirement was effective for fiscal years beginning after December 15, 2010 and for interim periods within those years.

 

Fair Value Measurements and Disclosures requires the disclosure in interim and annual periods of the inputs and valuation techniques used to measure fair value and a discussion of changes in valuation techniques and related inputs, if any, during the period.

 

In 2012, the Company engaged an independent valuation firm to provide a third-party review of our CLO fair value model relative to its functionality, model inputs and calculations as a reasonable method to determine CLO fair values, in the absence of Level 1 or Level 2 trading activity or observable market inputs. The independent valuation firm concluded that the Company’s CLO model appropriately factors in all the necessary inputs required to build a CLO equity cash flow model for fair value purposes and that the inputs were being employed correctly.

 

25
 

 

The Company has engaged an independent valuation firm to provide third party valuation consulting services to the Company’s Board of Directors. Each quarter the independent valuation firm will perform third party valuations on the Company’s investments on illiquid securities such that they are reviewed at least once during a trailing 12 month period. Third party valuations were performed on approximately 3% of investments at fair value excluding our investments in the Asset Manager Affiliates and CLO Fund Securities for the period ended March 31, 2013. These third party valuation estimates were considered as one of the relevant data inputs in the Company’s determination of fair value. The Board of Directors intends to continue to engage an independent valuation firm in the future to provide certain valuation services, including the review of certain portfolio assets, as part of the quarterly and annual year-end valuation process.

 

The Board of Directors may consider other methods of valuation than those set forth above to determine the fair value of Level III investments as appropriate in conformity with GAAP. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the Company’s investments may differ materially from the values that would have been used had a ready market existed for such investments. Further, such investments may be generally subject to legal and other restrictions on resale or otherwise be less liquid than publicly traded securities. In addition, changes in the market environment and other events may occur over the life of the investments that may cause the value realized on such investments to be different from the currently assigned valuations.

 

The Company’s valuation methodology and procedures are as follows:

 

  1) Each portfolio company or investment is cross-referenced to an independent pricing service to determine if a current market quote is available. The nature and quality of such quote is reviewed to determine reliability and relevance of the quote. Factors considered in this determination include whether the quote is from a transaction or is a broker quote, the date and aging of such quote, whether the transaction is arms-length, whether it is of a liquidation or distressed nature and certain other factors judged to be relevant by management within the framework of Fair Value Measurements and Disclosures.
     
  2) If an investment does not have a market quotation on either a broad market exchange or from an independent pricing service, the investment is initially valued by the Company’s investment professionals responsible for the portfolio investment in conjunction with the portfolio management team.
     
  3) Preliminary valuation conclusions are discussed and documented by management.
     
  4) Debt securities, equity securities, CLO Fund securities and the Asset Manager Affiliates will be selected for review by an independent valuation firm, which is engaged by the Company’s Board of Directors. Such independent valuation firm reviews management’s preliminary valuations and makes their own independent valuation assessment.
     
  5) The Valuation Committee of the Board of Directors reviews the portfolio valuations, as well as the input and report of such independent valuation firm, as applicable.
     
  6) Upon approval of the investment valuations by the Valuation Committee of the Board of Directors, the Audit Committee of the Board of Directors reviews the results for inclusion in the Company’s quarterly and annual financial statements, as applicable.
     
  7) The Board of Directors discusses the valuations and determines in good faith that the fair values of each investment in the portfolio is reasonable based upon any applicable independent pricing service, input of management, estimates from independent valuation firms (if any) and the recommendations of the Valuation Committee of the Board of Directors.

 

The majority of the Company’s investment portfolio is composed of debt and equity securities with unique contract terms and conditions and/or complexity that requires a valuation of each individual investment that considers multiple levels of market and asset specific inputs, including historical and forecasted financial and operational performance of the individual investment, projected cash flows, market multiples, comparable market transactions, the priority of the security compared with those of other securities for such issuers, credit risk, interest rates, and independent valuations and reviews.

 

Debt Securities. To the extent that the Company’s investments are exchange traded and are priced or have sufficient price indications from normal course trading at or around the valuation date (financial reporting date), such pricing will determine fair value. Pricing service marks from third party pricing services may be used as an indication of fair value, depending on the volume and reliability of the marks, sufficient and reasonable correlation of bid and ask quotes, and, most importantly, the level of actual trading activity. Further, the Company has been unable to identify directly comparable market indices or other market guidance that correlate directly to the types of investments the Company owns. As a result, for most of its assets, the Company determines fair value using alternative methodologies using available market data, as adjusted, to reflect the types of assets the Company owns, their structure, qualitative and credit attributes and other asset specific characteristics.

 

26
 

 

The Company derives fair value for its illiquid investments that do not have indicative fair values based upon active trades primarily by using a present value technique that discounts the estimated contractual cash flows for the underlying assets with discount rates imputed by broad market indices, bond spreads and yields for comparable issuers relative to the subject assets (the “Market Yield Approach”) and also considers recent loan amendments or other activity specific to the subject asset. Discount rates applied to estimated contractual cash flows for an underlying asset vary by specific investment, industry, priority and nature of the debt security (such as the seniority or security interest of the debt security) and are assessed relative to two indices, a leveraged loan index and a high-yield bond index, at the valuation date. The Company has identified these two indices as benchmarks for broad market information related to its loan and debt securities. Because the Company has not identified any market index that directly correlates to the loan and debt securities held by the Company and therefore uses the two benchmark indices, these market indices may require significant adjustment to better correlate such market data for the calculation of fair value of the investment under the Market Yield Approach. Such adjustments require judgment and may be material to the calculation of fair value. Further adjustments to the discount rate may be applied to reflect other market conditions or the perceived credit risk of the borrower. When broad market indices are used as part of the valuation methodology, their use is subject to adjustment for many factors, including priority, collateral used as security, structure, performance and other quantitative and qualitative attributes of the asset being valued. The resulting present value determination is then weighted along with any quotes from observable transactions and broker/pricing quotes. If such quotes are indicative of actual transactions with reasonable trading volume at or near the valuation date that are not liquidation or distressed sales, relatively more reliance will be put on such quotes to determine fair value. If such quotes are not indicative of market transactions or are insufficient as to volume, reliability, consistency or other relevant factors, such quotes will be compared with other fair value indications and given relatively less weight based on their relevancy. Other significant assumptions, such as coupon and maturity, are asset-specific and are noted for each investment in the Schedules of Investments.

 

Equity Securities. The Company’s equity securities in portfolio companies for which there is no liquid public market are carried at fair value based on the enterprise value of the portfolio company, which is determined using various factors, including EBITDA (earnings before interest, taxes, depreciation and amortization) and cash flows from operations less capital expenditures and other pertinent factors, such as recent offers to purchase a portfolio company’s securities or other liquidation events. The determined fair values are generally discounted to account for restrictions on resale and minority ownership positions. The values of the Company’s equity securities in public companies for which market quotations are readily available are based upon the closing public market prices on the balance sheet date. Securities that carry certain restrictions on sale are typically valued at a discount from the public market value of the security.

 

The significant inputs used to determine the fair value of equity securities include prices, earnings, EBITDA and cash flows after capital expenditures for similar peer comparables and the investment entity itself. Equity securities are classified as Level III, as described in Note 4 below, when there is limited activity or less transparency around inputs to the valuation given the lack of information related to such equity investments held in nonpublic companies. Significant assumptions observed for comparable companies are applied to relevant financial data for the specific investment. Such assumptions, such as model discount rates or price/earnings multiples, vary by the specific investment, equity position and industry and incorporate adjustments for risk premiums, liquidity and company specific attributes. Such adjustments require judgment and may be material to the calculation of fair value.

 

Asset Manager Affiliates. The Company’s investments in its wholly-owned asset management companies, the Asset Manager Affiliates, are carried at fair value, which is determined after taking into consideration a percentage of assets under management and a discounted cash flow model incorporating different levels of discount rates depending on the hierarchy of fees earned (including the likelihood of realization of senior, subordinate and incentive fees) and prospective modeled performance. Such valuation includes an analysis of comparable asset management companies. The Asset Manager Affiliates are classified as a Level III investment (as described below). Any change in value from period to period is recognized as net change in unrealized appreciation or depreciation.

 

CLO Fund Securities.  The Company typically makes a minority investment in the most junior class of securities of CLO Funds raised and managed by the Asset Manager Affiliates and may selectively invest in securities issued by funds managed by other asset management companies (collectively, “CLO Fund securities”). The Company’s CLO Fund securities generally relate to credit instruments issued by corporations.

 

27
 

 

The Company’s investments in CLO Fund securities are carried at fair value, which is based either on (i) the present value of the net expected cash inflows for interest income and principal repayments from underlying assets and cash outflows for interest expense, debt paydown and other fund costs for the CLO Funds that are approaching or past the end of their reinvestment period and therefore are selling assets and/or using principal repayments to pay down CLO Fund debt (or will begin to do so shortly), and for which there continue to be net cash distributions to the class of securities owned by the Company, or (ii) a discounted cash flow model for more recent CLO Funds that utilizes prepayment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow and comparable yields for similar securities or preferred shares to those in which the Company has invested or (iii) indicative prices provided by the underwriters or brokers who arrange CLO Funds. The Company recognizes unrealized appreciation or depreciation on the Company’s investments in CLO Fund securities as comparable yields in the market change and/or based on changes in net asset values or estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool. As each investment in CLO Fund securities ages, the expected amount of losses and the expected timing of recognition of such losses in the underlying collateral pool are updated and the revised cash flows are used in determining the fair value of the CLO Fund investment. The Company determines the fair value of its investments in CLO Fund securities on a security-by-security basis.

 

Due to the individual attributes of each CLO Fund security, they are classified as a Level III investment unless specific trading activity can be identified at or near the valuation date. When available, observable market information will be identified, evaluated and weighted accordingly in the application of such data to the present value models and fair value determination. Significant assumptions to the present value calculations include default rates, recovery rates, prepayment rates, investment/reinvestment rates and spreads and the discount rate by which to value the resulting underlying cash flows. Such assumptions can vary significantly, depending on market data sources which often vary in depth and level of analysis, understanding of the CLO market, detailed or broad characterization of the CLO market and the application of such data to an appropriate framework for analysis. The application of data points are based on the specific attributes of each individual CLO Fund security’s underlying assets, historic, current and prospective performance, vintage, and other quantitative and qualitative factors that would be evaluated by market participants. The Company evaluates the source of market data for reliability as an indicative market input, consistency amongst other inputs and results and also the context in which such data is presented.

 

For bond rated note tranches of CLO Fund securities (those above the junior class) without transactions to support a fair value for the specific CLO Fund and tranche, fair value is based on discounting estimated bond payments at current market yields, which may reflect the adjusted yield on the leveraged loan index for similarly rated tranches, as well as prices for similar tranches for other CLO Funds and also other factors such as indicative prices provided by underwriters or brokers who arrange CLO Funds, and the default and recovery rates of underlying assets in the CLO Fund, as may be applicable. Such model assumptions may vary and incorporate adjustments for risk premiums and CLO Fund specific attributes. Such adjustments require judgment and may be material to the calculation of fair value.

 

Cash. The Company places its cash with financial institutions and, at times, cash held in checking accounts may exceed the Federal Deposit Insurance Corporation insured limit.

 

Time Deposits and Money Market Accounts.  Time deposits primarily represent investments of cash held in a demand deposit accounts.  Money market accounts primarily represent short term interest-bearing deposit accounts including an account that contains restricted cash held for employee flexible spending accounts.

 

Interest Income.  Interest income, including the amortization of premium and accretion of discount, is recorded on the accrual basis to the extent that such amounts are expected to be collected. The Company generally places a loan or security on non-accrual status and ceases recognizing cash interest income on such loan or security when a loan or security becomes 90 days or more past due or if the Company otherwise does not expect the debtor to be able to service its debt obligations. Non-accrual loans remain in such status until the borrower has demonstrated the ability and intent to pay contractual amounts due or such loans become current. As of March 31, 2013, five issuers representing less than 1% of total investments at fair value were considered in default.

 

Dividends from Asset Manager Affiliates. The Company records dividend income from its Asset Manager Affiliates on the declaration date, which represents the ex-dividend date.

 

Dividend Income from CLO Fund Securities.  The Company generates dividend income from its investments in the most junior class of securities of CLO Funds (typically preferred shares or subordinated securities) managed by the Asset Manager Affiliates and selective investments in securities issued by funds managed by other asset management companies. The Company’s CLO Fund junior class securities are subordinated to senior note holders who typically receive a fixed rate of return on their investment. The CLO Funds are leveraged funds and any excess cash flow or “excess spread” (interest earned by the underlying securities in the fund less payments made to senior note holders and less fund expenses and management fees) is paid to the holders of the CLO Fund’s subordinated securities or preferred shares. The Company makes estimated interim accruals of such dividend income based on recent historical distributions and CLO Fund performance and adjusts such accruals on a quarterly basis to reflect actual distributions.

 

28
 

 

For non-junior class CLO Fund securities, such as the Company’s investment in the Class B-2L Notes of the Katonah 2007-I CLO and Class F Notes of the Catamaran 2012-1 CLO, interest is earned at a fixed spread relative to the LIBOR index.

 

Capital Structuring Service Fees. The Company may earn ancillary structuring and other fees related to the origination, investment, disposition or liquidation of debt and investment securities. Generally, the Company will capitalize loan origination fees, then amortize these fees into interest income over the term of the loan using the effective interest rate method, recognizes prepayment and liquidation fees upon receipt and equity structuring fees as earned, which generally occurs when an investment transaction closes.

 

Debt Issuance Costs.  Debt issuance costs represent fees and other direct costs incurred in connection with the Company’s borrowings. These amounts are capitalized and amortized ratably over the contractual term of the borrowing.

 

During March 2011, the Company issued $60 million of Convertible Senior Notes (the “Convertible Senior Notes”) and incurred debt issuance costs of approximately $2.3 million which are being amortized over a five-year period. During October 2012, the Company issued $41.4 million of 7.375% Senior Notes due 2019 (the “Senior Notes”) and incurred debt issuance costs of approximately $1.5 million, which are being amortized over a seven year period. At March 31, 2013, there was an unamortized debt issuance cost of approximately $2.8 million included in other assets in the accompanying balance sheet. Amortization expense for the three months ended March 31, 2013 and 2012 was approximately $149,000 and $118,000, respectively, and is included in interest and amortization of debt issuance costs on the Statement of Operations.

 

Expenses. The Company is internally managed and expenses costs, as incurred, with regard to the running of its operations. Primary operating expenses include employee salaries and benefits, the costs of identifying, evaluating, negotiating, closing, monitoring and servicing the Company’s investments and related overhead charges and expenses, including rental expense, and any interest expense incurred in connection with borrowings. The Company and the Asset Manager Affiliates share office space and certain other operating expenses. The Company has entered into an Overhead Allocation Agreement with the Asset Manager Affiliates which provides for the sharing of such expenses based on an equal sharing of office lease costs and the ratable usage of other shared resources.

 

Dividends. Dividends and distributions to common stockholders are recorded on the ex-dividend date. The amount to be paid out as a dividend is determined by the Board of Directors each quarter and is generally based upon the distributable taxable income estimated by management for the period and year.

 

The Company has adopted a dividend reinvestment plan that provides for reinvestment of its distributions on behalf of its stockholders, unless a stockholder “opts out” of the plan to receive cash in lieu of having their cash dividends automatically reinvested in additional shares of the Company’s common stock.

 

3. EARNINGS PER SHARE

 

The following information sets forth the computation of basic and diluted net increase (decrease) in stockholders’ equity per share for the three months ended March 31, 2013 and 2012 (unaudited):

 

   Three Months Ended March 31, 
   2013   2012 
         
Net increase in net assets from operations   $7,213,281   $576,657 
Net decrease in net assets allocated to unvested share awards    (7,935)   (7,777)
Add: Interest on Senior Convertible Notes    1,312,500     
Add: Amortization of Capitalized Costs on Senior Convertible Notes    106,115     
            
Net increase in net assets available to common stockholders    8,623,961    568,880 
Weighted average number of common shares outstanding for basic shares computation    29,266,186    24,270,825 
Effect of dilutive securities - stock options    15,689     
Effect of dilutive Senior Convertible Notes    7,353,828     
            
Weighted average number of common and common stock equivalent shares outstanding for diluted shares computation    36,635,703    24,270,825 
            
Net increase in net assets per basic common shares:           
Net increase in net assets from operations    0.25    0.02 
Net increase in net assets per diluted shares:           
Net increase in net assets from operations    0.24    0.02 

 

29
 

 

Share-based awards that contain nonforfeitable rights to dividends or dividend equivalents, whether paid or unpaid, are participating securities and included in the computation of both basic and diluted earnings per share. Grants of restricted stock awards to our employees and directors are considered participating securities when there are earnings in the period and the earnings per share calculations include outstanding unvested restricted stock awards in the basic weighted average shares outstanding calculation.

 

The Company’s Convertible Senior Notes are included in the computation of the diluted net increase or decrease in net assets resulting from operations per share in accordance with ASC 261-10-45-40-b by application of the “if-converted method.” Under the if-converted method, interest charges applicable to the convertible debt for the period are added to the reported net increase or decrease in net assets resulting from operations and the full amount of shares (pro-rata if not outstanding for the full period) that would be issued are added to weighted average basic shares. Convertible debt is considered anti-dilutive only when its interest per share upon conversion exceeds the basic net increase or decrease in net assets resulting from operations per share. For the three months ended March 31, 2013, the effect of the convertible debt was dilutive. For the three months ended March 31, 2012, the effect of the convertible debt was antidilutive.

 

The if-converted method of computing the dilutive effects on convertible debt assumes a conversion even if the contracted conversion price exceeds the market value of the shares. The current conversion price of the convertible senior is approximately 122.5638 shares of our common stock per $1,000 principal amount of the Convertible Senior Notes, equivalent to a conversion price of approximately $8.159 per share of our common stock. Upon conversion, the Company would issue the full amount of common stock upon conversion and retire the full amount of debt outstanding.

 

4. INVESTMENTS

 

The Company invests in senior secured loans and mezzanine debt and, to a lesser extent, equity capital of middle market companies in a variety of industries. The Company generally targets companies that generate positive cash flows because the Company looks to cash flows as the primary source for servicing debt. However, the Company may invest in other companies if it is presented with attractive opportunities.

 

The following table shows the Company’s portfolio by security type at March 31, 2013 and December 31, 2012:

 

   March 31, 2013 (unaudited)   December 31, 2012 
Security Type  Cost   Fair Value      Cost   Fair Value    
Time Deposits  $-   $-    -%  $1,942,834   $1,942,834    1%
Money Market Account   38,887,925    38,887,925    15    30,543,824    30,543,824    15 
Senior Secured Loan   81,306,958    74,471,738    28    67,874,565    60,258,885    29 
Junior Secured Loan   54,430,898    39,532,069    15    49,646,273    33,486,956    17 
Senior Unsecured Loan   20,000,000    20,000,000    8    -    -    - 
First Lien Bond   2,930,343    3,000,000    1    2,928,762    3,000,000    1 
Senior Subordinated Bond   2,728,878    2,749,634    1    2,729,088    2,735,881    1 
Senior Unsecured Bond   10,805,507    11,422,500    4    10,798,463    11,185,000    5 
CLO Fund Securities   90,105,528    78,270,059    29    90,146,410    83,257,507    40 
Equity Securities   18,260,008    7,839,699    3    18,375,588    8,020,716    4 
Preferred Stock   400,000    373,880    -    400,000    371,160    - 
Asset Manager Affiliates   83,198,191    80,354,000    30    83,161,529    77,242,000    37 
                               
Total  $403,054,236   $356,901,504    134%  $358,547,336   $312,044,763    150%

 

 

1 Calculated as a percentage of net asset value.

 

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The industry concentrations based on the fair value of the Company’s investment portfolio as of March 31, 2013 and December 31, 2012, were as follows:

 

   March 31, 2013 (unaudited)   

December 31, 2012

 
Industry Classification  

Cost

  

Fair Value

  

%1

    

Cost

  

Fair Value

  

%1

 
Aerospace and Defense   $5,284,206   $3,881,141    1%    $5,278,896   $3,874,742    2%
Asset Management Companies2   83,198,191    80,354,000    30      83,161,529    77,242,000    37 
Automobile    7,895,901    7,992,741    3      4,945,695    5,011,608    2 
Beverage, Food and Tobacco   18,490,729    18,629,546    7      18,112,772    18,285,421    9 
Broadcasting and Entertainment   1,980,643    1,996,239    1      1,978,846    1,990,930    1 
Buildings and Real Estate   18,535,511    472,780    -      18,535,511    455,524    - 
Chemicals, Plastics and Rubber    2,947,249    2,981,437    1      2,954,773    2,950,577    1 
CLO Fund Securities    90,105,547    78,270,059    29      90,146,410    83,257,507    40 
Containers, Packaging and Glass    1,947,316    1,984,609    1      1,949,236    1,971,898    1 
Diversified/Conglomerate Service    5,517,800    3,728,676    1      5,520,217    3,536,426    2 
Electronics    7,869,854    8,021,773    3      6,137,592    6,252,380    3 
Finance   24,760,164    24,999,000    9      4,748,767    4,891,710    2 
Healthcare, Education and Childcare    23,688,334    12,657,758    5      15,981,824    4,618,521    2 
Home and Office Furnishings, Housewares, and Durable Consumer Products    10,208,003    11,089,108    4      10,820,467    11,613,621    5 
Insurance    6,973,061    7,019,738    3      6,970,307    6,433,130    3 
Leisure, Amusement, Motion Pictures, Entertainment   2,491,007    2,076,818    1      2,491,007    2,053,481    1 
Machinery (Non-Agriculture, Non-Construction, Non-Electronic)    11,411,550    11,383,178    4      11,408,091    11,581,245    6 
Mining, Steel, Iron and Non-Precious Metals    773,718    264,864    -      773,718    264,864    - 
Oil and Gas    11,703,185    11,965,282    6      11,692,913    11,692,000    6 
Personal and Non Durable Consumer Products (Mfg. Only)   8,043,808    7,416,500    3      5,000,000    3,977,100    2 
Personal, Food and Miscellaneous Services    3,567,229    3,665,180    1      3,574,421    3,640,835    2 
Personal Transportation   2,015,824    2,011,209    1      2,012,685    2,005,353    1 
Printing and Publishing   5,868,534    6,240,829    2      2,961,395    3,231,314    2 
Retail Stores    5,780,261    5,862,916    2      5,781,672    5,772,767    3 
Telecommunications    2,939,341    2,878,667    1      2,952,654    2,783,195    1 
Time Deposit and Money Market Accounts    38,887,925    38,887,924    15      32,486,658    32,486,658    16 
Utilities    169,345    169,532    -      169,280    169,956    - 
                                  
Total   $403,054,236   $356,901,504    134%    $358,547,336   $312,044,763    150%

 

 

1Calculated as a percentage of net asset value.

 

2Represents the Asset Manager Affiliates.

 

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The Company may invest up to 30% of the investment portfolio in opportunistic investments in high-yield bonds, debt and equity securities of CLO Funds, distressed debt or equity securities of public companies. The Company expects that these public companies generally will have debt that is non-investment grade. The Company also may invest in debt of middle market companies located outside of the United States.

 

At March 31, 2013 and December 31, 2012, approximately 22% and 27% of the Company’s investments were foreign assets (including the Company’s investments in CLO Funds, which are typically domiciled outside the U.S. and represented approximately 22% and 27% of its portfolio on such dates), respectively.

 

At March 31, 2013 and December 31, 2012, the Company’s ten largest portfolio companies represented approximately 61% and 62%, respectively, of the total fair value of its investments. The Company’s largest investment, the Asset Manager Affiliates which are its wholly owned asset manager affiliates represented 23% and 25% of the total fair value of the Company’s investments at March 31, 2013 and December 31, 2012, respectively. Excluding the Asset Manager Affiliates and CLO Fund securities, the Company’s ten largest portfolio companies represented approximately 20% and 17% of the total fair value of the Company’s investments at March 31, 2013 and December 31, 2012, respectively.

 

Investment in CLO Fund Securities

 

The Company typically makes a minority investment in the most junior class of securities of CLO Funds (typically preferred shares or subordinated securities) managed by the Asset Manager Affiliates and may selectively invest in securities issued by funds managed by other asset management companies. Preferred shares or subordinated securities issued by CLO Funds are entitled to recurring dividend distributions which generally equal the net remaining cash flow of the payments made by the underlying CLO Fund’s securities less contractual payments to senior bond holders and CLO Fund expenses. CLO Funds managed by the Asset Manager Affiliates (“CLO Fund securities managed by affiliates”) invest primarily in broadly syndicated non-investment grade loans, high-yield bonds and other credit instruments of corporate issuers. The underlying assets in each of the CLO Funds in which the Company has an investment are generally diversified secured or unsecured corporate debt. The CLO Funds are leveraged funds and any excess cash flow or “excess spread” (interest earned by the underlying securities in the fund less payments made to senior bond holders, fund expenses and management fees) is paid to the holders of the CLO Fund’s subordinated securities or preferred shares.

 

The subordinated securities and preferred share securities are considered equity positions in the CLO Funds and, as of March 31, 2013 and December 31, 2012, the Company had approximately $78 million and $83 million, respectively, of CLO Fund securities at fair value. The cost basis of the Company’s investment in CLO Fund securities as of March 31, 2013 was approximately $90 million and aggregate unrealized depreciation on the CLO Fund securities totaled approximately $12 million. The cost basis of the Company’s investment in CLO Fund equity securities as of December 31, 2012, was approximately $90 million and aggregate unrealized depreciation on the CLO Fund securities totaled approximately $7 million.

 

In December 2012, the Company purchased $4.5 million par value of the class F Notes and $8.9 million par value of the Subordinated Notes of Catamaran 2012-1 CLO (“Catamaran 2012-1”) managed by Trimaran Advisors. The Company purchased the class F and subordinated notes for 84% and 100% of the par value, respectively.

 

All CLO Funds managed by the Asset Manager Affiliates are currently making quarterly dividend distributions to the Company and are paying all senior and subordinate management fees to the Asset Manager Affiliates. With the exception of the Katonah III, Ltd. and the Katonah V, Ltd. CLO Funds, all third-party managed CLO Funds held as investments are making quarterly dividend distributions to the Company.

 

Fair Value Measurements

 

The Company follows the provisions of Fair Value Measurements and Disclosures, which among other matters, requires enhanced disclosures about investments that are measured and reported at fair value. This standard defines fair value and establishes a hierarchal disclosure framework which prioritizes and ranks the level of market price observability used in measuring investments at fair value and expands disclosures about assets and liabilities measured at fair value. Fair Value Measurements and Disclosures defines “fair value” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This fair value definition focuses on an exit price in the principal, or most advantageous market, and prioritizes, within a measurement of fair value, the use of market-based inputs (which may be weighted or adjusted for relevance, reliability and specific attributes relative to the subject investment) over entity-specific inputs. Market price observability is affected by a number of factors, including the type of investment and the characteristics specific to the investment. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. Subsequent to the adoption of Fair Value Measurements and Disclosures, the FASB has issued various staff positions clarifying the initial standard (see Note 2. “Significant Accounting Policies—Investments”).

 

32
 

 

Fair Value Measurements and Disclosures establishes the following three-level hierarchy, based upon the transparency of inputs to the fair value measurement of an asset or liability as of the measurement date:

 

Level I – Unadjusted quoted prices are available in active markets for identical investments as of the reporting date. The type of investments included in Level I include listed equities and listed securities. As required by Fair Value Measurements and Disclosures, the Company does not adjust the quoted price for these investments, even in situations where the Company holds a large position and a sale could reasonably affect the quoted price.

 

Level II – Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date. Such inputs may be quoted prices for similar assets or liabilities, quoted markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full character of the financial instrument, or inputs that are derived principally from, or corroborated by, observable market information. Investments which are generally included in this category include illiquid debt securities and less liquid, privately held or restricted equity securities for which some level of recent trading activity has been observed.

 

Level III – Pricing inputs are unobservable for the investment and includes situations where there is little, if any, market activity for the investment. The inputs may be based on the Company’s own assumptions about how market participants would price the asset or liability or may use Level II inputs, as adjusted, to reflect specific investment attributes relative to a broader market assumption. These inputs into the determination of fair value may require significant management judgment or estimation. Even if observable market data for comparable performance or valuation measures (earnings multiples, discount rates, other financial/valuation ratios, etc.) are available, such investments are grouped as Level III if any significant data point that is not also market observable (private company earnings, cash flows, etc.) is used in the valuation methodology.

 

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and the Company considers factors specific to the investment. A majority of the Company’s investments are classified as Level III. The Company evaluates the source of inputs, including any markets in which its investments are trading, in determining fair value. Inputs that are backed by actual transactions, those that are highly correlated to the specific investment being valued and those derived from reliable or knowledgeable sources will tend to have a higher weighting in determining fair value. Ongoing reviews by the Company’s investment analysts, Chief Investment Officer, Valuation Committee and independent valuation firms (if engaged) are based on an assessment of each underlying investment, its current and prospective operating and financial performance, consideration of financing and sale transactions with third parties, expected cash flows and market-based information, including comparable transactions, performance factors, and other investment or industry specific market data, among other factors.

 

The following table summarizes the fair value of investments by the above Fair Value Measurements and Disclosures fair value hierarchy levels as of March 31, 2013 (unaudited) and December 31, 2012, respectively:

 

As of March 31, 2013 (unaudited)

 

    Level I   Level II   Level III   Total  
Money market account   $ —    $ 38,887,925   $ —    $ 38,887,925  
Debt securities     —      70,429,249     81,120,572     151,549,821  
CLO Fund securities     —      —      78,270,059     78,270,059  
Equity securities     —      —      7,839,699     7,839,699  
Asset Manager Affiliates     —      —      80,354,000     80,354,000  
                           
Total     —      109,317,174     247,584,330     356,901,504  

 

As of December 31, 2012

 

    Level I   Level II   Level III   Total  
Time deposit and money market account   $ —    $ 32,486,658   $ —    $ 32,486,658  
Debt securities     —      59,172,476     51,865,406     111,037,882  
CLO Fund securities     —      —      83,257,507     83,257,507  
Equity securities     —      —      8,020,716     8,020,716  
Asset Manager Affiliates     —      —      77,242,000     77,242,000  
                           
Total     —      91,659,134     220,385,629     312,044,763  

 

33
 

 

As a BDC, it is required that the Company invest primarily in the debt and equity of non-public for which there is little, if any, market-observable information. As a result a significant portion of the Company’s investments at any given time will likely be deemed Level III investments. The Company believes that investments classified as Level III for Fair Value Measurements and Disclosures have a further hierarchal framework which prioritizes and ranks such valuations based on the degree of independent and observable inputs, objectivity of data and models and the level of judgment required to adjust comparable data. The hierarchy of such methodologies are presented in the above table and discussed below in descending rank.

 

Investment values derived by a third party pricing service are generally deemed to be Level III values. For those that have observable trades, we consider them to be Level II.

 

The Company derives fair value for its illiquid investments that do not have indicative fair values based upon active trades primarily by using the Market Yield Approach and also considers recent loan amendments or other activity specific to the subject asset. Discount rates applied to estimated contractual cash flows for an underlying asset vary by specific investment, industry, priority and nature of the debt security (such as the seniority or security interest of the debt security) and are assessed relative to two indices, a leveraged loan index and a high-yield bond index, at the valuation date. The Company has identified these two indices as benchmarks for broad market information related to its loan and debt investments. Because the Company has not identified any market index that directly correlates to the loan and debt investments held by the Company and therefore uses the two benchmark indices, these market indices may require significant adjustment to better correlate such market data for the calculation of fair value of the investment under the Market Yield Approach. Such adjustments require judgment and may be material to the calculation of fair value. Further adjustments to the discount rate may be applied to reflect other market conditions or the perceived credit risk of the borrower. When broad market indices are used as part of the valuation methodology, their use is subject to adjustment for many factors, including priority, collateral used as security, structure, performance and other quantitative and qualitative attributes of the asset being valued. The resulting present value determination is then weighted along with any quotes from observable transactions and broker/pricing quotes. If such quotes are indicative of actual transactions with reasonable trading volume at or near the valuation date that are not liquidation or distressed sales, relatively more reliance will be put on such quotes to determine fair value. If such quotes are not indicative of market transactions or are insufficient as to volume, reliability, consistency or other relevant factors, such quotes will be compared with other fair value indications and given relatively less weight based on their relevancy. The appropriateness of specific valuation methods and techniques may change as market conditions and available data change.

 

In 2012, the Company engaged an independent valuation firm to provide a third-party review of our CLO fair value model relative to its functionality, model inputs, and calculations as a reasonable method to determine CLO fair values, in the absence of Level I or Level II trading activity or observable market inputs. The independent valuation firm concluded that the Company’s CLO model appropriately factors in all the necessary inputs required to build a CLO equity cash flow for fair value purposes and that the inputs were being employed correctly.

 

The Company has engaged an independent valuation firm to provide third party valuation consulting services to the Company’s Board of Directors. Each quarter the independent valuation firm will perform third party valuations on the Company’s investments on illiquid securities such that they are reviewed at least once during a trailing 12 month period. These third party valuation estimates were considered as one of the relevant data inputs in the Company’s determination of fair value. The Board of Directors intends to continue to engage an independent valuation firm in the future to provide certain valuation services, including the review of certain portfolio assets, as part of the quarterly and annual year-end valuation process.

 

Values derived for debt and equity securities using public/private company comparables generally utilize market-observable data from such comparables and specific, non-public and non-observable financial measures (such as earnings or cash flows) for the private, underlying company/issuer. Such non-observable company/issuer data is typically provided on a monthly basis, is certified as correct by the management of the company/issuer and/or audited by an independent accounting firm on an annual basis. Since such private company/issuer data is not publicly available it is not deemed market-observable data and, as a result, such investment values are grouped as Level III assets.

 

Values derived for the Asset Manager Affiliates using public/private company comparables generally utilize market-observable data from such comparables and specific, non-public and non-observable financial measures (such as assets under management, historical and prospective earnings) for the Asset Manager Affiliates. The Company recognizes that comparable asset managers may not be fully comparable to the Asset Manager Affiliates and typically identifies a range of performance measures and/or adjustments within the comparable population with which to determine value. Since any such ranges and adjustments are entity specific they are not considered market-observable data and thus require a Level III grouping. Illiquid investments that have values derived through the use of discounted cash flow models and residual enterprise value models are grouped as Level III assets.

 

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The changes in investments measured at fair value for which the Company has used unobservable inputs to determine fair value are as follows:

 

As of March 31, 2013, the Company’s Level II portfolio investments were valued by a third party pricing service for which the prices are not adjusted and for which inputs are observable or can be corroborated by observable market data for substantially the full character of the financial instrument, or inputs that are derived principally from, or corroborated by, observable market information. The fair value of the Company’s Level II portfolio investments was $109,317,174 as of March 31, 2013.

 

As of March 31, 2013, the Company’s Level III portfolio investments had the following valuation techniques and significant inputs:

 

Type Fair Value Valuation Technique Unobservable Inputs Range of Inputs  
 
Debt Securities $1,403,876 Enterprise Value Average EBITDA Multiple 7.9x  
Weighted Avg Cost of Capital 12.1%  
$48,795,777 Income Approach Market Yield 4.0% - 21.1% (weighted average 7.3%)  
$30,352,595 Market Approach Third Party Bid 1 - 100.7 (weighted average 99.3)  
$1,000 Options Value Qualitative Inputs    
$567,324 Recovery Approach Qualitative Inputs    
Equity Securities $7,839,699 Enterprise Value Average EBITDA Multiple 4.2x – 7.2x (weighted average 6.1x)  
Weighted Avg Cost of Capital 9.3% - 14.4% (weighted average 15.7%)  
CLO Fund Securities $66,492,259 Discounted Cash Flow Discount Rate 7.5%-14% (weighted average 13.0%)  
Probability of Default 1.00%-2.50% (weighted average 1.47% - 2.18%)  
Loss Severity 30%-40% (weighted average 31% - 36%)  
Recovery Rate 60%-70% (weighted average 64% - 69%)  
Prepayment Rate 25%  
$11,777,800 Market Approach Third Party Bid 87 - 88  
Asset Manager Affiliates $80,354,000 Discounted Cash Flow Discount Rate 1.5% - 11.87% (weighted average 7.88%)  
TOTAL $247,584,330        

 

The significant unobservable inputs used in the fair value measurement of the Company’s debt securities include the comparable yields of similar investments in similar industries, effective discount rates, average EBITDA multiples, and weighted average cost of capital. Significant increases or decreases in such comparable yields would result in a significantly lower or higher fair value measurement.

 

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The significant unobservable inputs used in the fair value measurement of the Company’s equity securities include the EBITDA multiple of similar investments in similar industries and the weighted average cost of capital. Significant increases or decreases in such inputs would result in a significantly lower or higher fair value measurement.

 

Significant unobservable inputs used in the fair value measurement of the Company’s CLO Fund securities include default rates, recovery rates, prepayment rates, and spreads and the discount rate by which to value the resulting underlying cash flows. Such assumptions can vary significantly, depending on market data sources which often vary in depth and level of analysis, understanding of the CLO market, detailed or broad characterization of the CLO market and the application of such data to an appropriate framework for analysis. The application of data points are based on the specific attributes of each individual CLO Fund security’s underlying assets, historic, current and prospective performance, vintage, and other quantitative and qualitative factors that would be evaluated by market participants. The Company evaluates the source of market data for reliability as an indicative market input, consistency amongst other inputs and results and also the context in which such data is presented. Significant increases or decreases in probability of default and loss severity inputs in isolation would result in a significantly lower or higher fair value measurement. In general, a change in the assumption of the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity in an event of default. Significant increases or decreases in the discount rate in isolation would result in a significantly lower or higher fair value measurement.

 

The significant unobservable inputs used in the fair value measurement of the Asset Manager Affiliates is the discount rate used to present value prospective cash flows. Prospective revenues are generally based on a fixed percentage of the par value of CLO Fund assets under management and are recurring in nature for the term of the CLO Fund so long as the Asset Manager Affiliates manage the fund. As a result, the annual management fees earned by the Asset Manager Affiliates are not subject to market value fluctuations in the underlying collateral. The discounted cash flow model incorporates different levels of discount rates depending on the hierarchy of fees earned (including the likelihood of realization of senior, subordinate and incentive fees) and prospective modeled performance. Significant increases or decreases in such discount rate would result in a significantly lower or higher fair value measurement.

 

The qualitative inputs used in the fair value measurements of the Debt Securities include estimates of the distressed liquidation value of the pledged collateral.

 

5. ASSET MANAGER AFFILIATES

 

The Asset Manager Affiliates are wholly-owned portfolio companies. The Asset Manager Affiliates manage CLO Funds primarily for third party investors that invest in broadly syndicated loans, high yield bonds and other credit instruments issued by corporations. At March 31, 2013, Asset Manager Affiliates had approximately $3.5 billion of par value of assets under management, and the Company’s 100% equity interest in the Asset Manager Affiliates was valued at approximately $80 million.

 

As a manager of the CLO Funds, the Asset Manager Affiliates receive contractual and recurring management fees from the CLO Funds for their management and advisory services. The annual fees which the Asset Manager Affiliates receive are generally based on a fixed percentage of assets under management (at par value and not subject to changes in market value), and the Asset Manager Affiliates generate annual operating income equal to the amount by which their fee income exceeds their operating expenses. The annual management fees the Asset Manager Affiliates receive have two components - a senior management fee and a subordinated management fee. Currently, all CLO Funds managed by the Asset Manager Affiliates are paying both their senior and subordinated management fees on a current basis.

 

The revenue that the Asset Manager Affiliates generate through the fees they receive for managing CLO Funds and after paying the expenses associated with their operations, including compensation of their employees, may be distributed to the Company. Any distributions of the Asset Manager Affiliates’ net income are recorded as “dividends from affiliate asset managers” and are recorded as declared (where declaration date represents ex-dividend date) by the Asset Manager Affiliates as income on the Company’s statement of operations. For the three months ended March 31, 2013, the Asset Manager Affiliates made distributions of $3 million to the Company. For the three months ended March 31, 2012, the Asset Manager Affiliates made distributions of $825,000 to the Company; dividends are recorded as declared (where declaration date represents ex-dividend date) by the Asset Manager Affiliates as income on the Company’s statement of operations.

 

As with all other investments, the Asset Manager Affiliates’ fair value is determined quarterly. The valuation is primarily based on an analysis of both a percentage of their assets under management and the Asset Manager Affiliates’ estimated operating income. Any change in value from period to period is recognized as unrealized gain or loss. See Note 2, “Significant Accounting Policies” and Note 4, “Investments” for further information relating to the Company’s valuation methodology. For the three months ended March 31, 2013 the Asset Manager Affiliates had an increase in unrealized appreciation of approximately $3.1 million.

 

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Effective January 1, 2010, the Asset Manager Affiliates adopted guidance encompassed in Accounting Standards Codification Topic 810, “Consolidation.” The adoption of this new guidance had an impact on the disclosures relating to the Asset Manager Affiliates which had previously not been required, as its provisions require the Asset Manager Affiliates to consolidate certain of their managed CLO Funds that were not previously consolidated. As a result of the consolidation of these CLO Funds into the Asset Manager Affiliates, the financial results of the Asset Manager Affiliates indicate that they qualify as a “significant subsidiary” of the Company requiring the following additional disclosures. In addition, Katonah 2007-I CLO qualifies as a “significant subsidiary” of the Company and is also required to make the additional disclosures. These disclosures regarding the Asset Manager Affiliates and Katonah 2007-I CLO do not directly impact the financial position, results of operations or cash flows of the Company.

 

Asset Manager Affiliates  
Summarized Balance Sheet Information (unaudited)  
               

   As of   As of 
   March 31, 2013   December 31, 2012 
Investments of CLO Funds, at fair value  $3,153,246,598   $3,255,805,442 
Restricted cash of CLO Funds   399,208,297    53,322,266 
Total assets   3,667,735,603    3,847,297,787 
CLO Fund liabilities at fair value   3,385,428,629    3,459,529,711 
Total liabilities   3,529,735,430    3,698,915,974 
Appropriated retained earnings of consolidated VIEs   92,826,264    104,870,995 

 

Asset Manager Affiliates  
Summarized Statements of Operations Information (unaudited)  
               

   For the three months ended 
   March 31, 
   2013   2012 
Interest income - investments of CLO Funds  $33,267,427   $29,764,690 
Total income   36,311,272    32,187,154 
Interest expense of CLO Fund liabilities   29,772,085    30,541,329 
Total expenses   34,844,224    34,777,990 
Net realized and unrealized gains (losses)   (9,478,937)   (6,226,958)
Net income (loss) attributable to noncontrolling interests in consolidated consolidated Variable Interest Entities   (9,171,141)   (8,615,948)
Net income (loss) attributable to Asset Manager Affiliates   762,649    (380,021)

 

Katonah 2007-I CLO Ltd.
Summarized Balance Sheet Information (unaudited)
     

   As of 
   March 31, 2013 
Total investments at fair value  $302,464,094 
Cash   22,944,935 
Total assets   329,213,882 
CLO Debt at fair value   314,551,967 
Total liabilities   322,522,864 
Total Net Assets   6,691,012 

 

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Katonah 2007-I CLO Ltd.
Summarized Statements of Operations Information (unaudited)
     
   For the three
months ended
 
   March 31, 
   2013 
Interest income from investments  $3,225,687 
Total income   3,386,608 
Interest expense   2,993,892 
Total expenses   3,270,996 
Net realized and unrealized gains (losses)   (1,759,451)
Decrease in net assets resulting from operations   (1,643,839)

 

All of the consolidated VIEs’ investment balances are CLO Fund-related. The assets of the CLO Funds are held solely to satisfy the obligations of the CLO Funds. The Asset Manager Affiliates have no right to the benefits from, nor do they bear the risks associated with, the collateral assets held by the CLO Funds, beyond the management fees generated from the CLO Funds. If the Asset Manager Affiliates were to liquidate, the collateral assets would not be available to the general creditors of the Asset Manager Affiliates. Additionally, the investors in the CLO Funds have no recourse to the general credit of the Asset Manager Affiliates for the securities issued by the CLO Funds.

 

The consolidation of the VIEs’ investment products in the Asset Manager Affiliates’ financial statements is not reflective of the underlying financial position, results of operations or cash flows of the Asset Manager Affiliates as stand-alone entities. Furthermore, the financial operations of the Asset Manager Affiliates, whether consolidated with the CLO funds they manage or on a stand-alone basis, are not reflective of the fair value of the Asset Manager Affiliates as reported on the Company’s balance sheet and schedule of investments as the Company is required under U.S. GAAP to report the Asset Manager Affiliates as a portfolio company at fair value.

 

As separately regarded entities for tax purposes, the Asset Manager Affiliates are taxed at normal corporate rates. For tax purposes, any distributions of taxable net income earned by the Asset Manager Affiliates to the Company would generally need to be distributed to the Company’s shareholders. Generally, such distributions of the Asset Manager Affiliates’ income to the Company’s shareholders will be considered as qualified dividends for tax purposes. The Asset Manager Affiliates’ taxable net income will differ from U.S. GAAP net income because of deferred tax timing adjustments and permanent tax adjustments. Deferred tax timing adjustments may include differences for the recognition and timing of depreciation, bonuses to employees and stock option expense. Permanent differences may include adjustments, limitations or disallowances for meals and entertainment expenses, penalties, tax goodwill amortization and net operating loss carryforward.

 

Goodwill amortization for tax purposes was created upon the purchase of 100% of the equity interests in Katonah Debt Advisors prior to the Company’s IPO in exchange for shares of the Company’s stock valued at $33 million. Although this transaction was a stock transaction rather than an asset purchase and thus no goodwill was recognized for U.S. GAAP purposes, such exchange was considered an asset purchase under Section 351(a) of the Code. At the time of the transfer, Katonah Debt Advisors had equity of approximately $1 million resulting in tax goodwill of approximately $32 million which will be amortized for tax purposes on a straight-line basis over 15 years, which accounts for an annual difference between U.S. GAAP income and taxable income by approximately $2 million per year over such period.

 

Additional goodwill amortization for tax purposes was created upon the purchase of 100% of the equity interests in Trimaran Advisors by its sole member, Commodore Holdings, L.L.C., in exchange for shares of the KCAP Financial’s stock valued at $25.5 million and cash of $13.0 million. The transaction was considered an asset purchase under Section 351(a) of the Code and resulted in tax goodwill of approximately $22.8 million which will be amortized for tax purposes on a straight-line basis over 15 years, which accounts for an annual difference between GAAP income and taxable income by approximately $1.5 million per year over such period. 

 

At March 31, 2013 there were no intercompany balances with our affiliates.

 

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Related Party Transactions

 

On November 20, 2012, the Company entered into a senior credit agreement (the “Senior Credit Facility”) with Trimaran Advisors, pursuant to which Trimaran Advisors may borrow from time to time up to $20 million from the Company in order to provide the capital necessary to support one or more of Trimaran Advisors’ warehouse lines and/or working capital in connection with Trimaran Advisors’ warehouse activities. The Senior Credit Facility expires on November 20, 2017 and bears interest at an annual rate of 9.0%. The Company’s average debt obligation relating to the Senior Credit Facility was $20 million. As of December 27, 2012, the Senior Credit Facility was terminated and there were no borrowings outstanding.

 

On February 26, 2013, the Company entered into a senior credit agreement (the “Trimaran Credit Facility”) with Trimaran Advisors, pursuant to which Trimaran Advisors may borrow from time to time up to $20 million from the Company in order to provide capital necessary to support one or more of Trimaran Advisors’ warehouse lines of credit and/or working capital in connection with Trimaran Advisors’ warehouse activities. The Trimaran Credit Facility expires on November 20, 2017 and bears interest at an annual rate of 9.0%. At March 31, 2013, $20 million was outstanding under the Trimaran Credit Facility.

 

On April 15, 2013, the Trimaran Credit Facility was amended and upsized from $20 million to $23 million.

 

For the three months end March 31, 2013 the Company recognized interest income related to the Senior Credit Facility of $170,000.

 

6. BORROWINGS

 

The Company’s debt obligations consist of the following:

 

   As of
March 31, 2013
(unaudited)
   As of
December 31, 2012
 
             
Convertible Senior Notes, due March 15, 2016   $60,000,000   $60,000,000 
Senior Notes, due September 30, 2019   $41,400,000   $41,400,000 

 

Convertible Senior Notes

 

On March 16, 2011, the Company issued $55 million in aggregate principal amount of unsecured 8.75% convertible senior notes due March 2016 (“Convertible Senior Notes”). On March 23, 2011, pursuant to an over-allotment option, the Company issued an additional $5 million of such Convertible Senior Notes for a total of $60 million in aggregate principal amount. The net proceeds from the sale of the Convertible Senior Notes, following underwriting expenses, were approximately $57.7 million. Interest on the Convertible Senior Notes is paid semi-annually in arrears on March 15 and September 15, at a rate of 8.75%, commencing September 15, 2011. The Notes mature on March 15, 2016 unless converted earlier. The Convertible Senior Notes are senior unsecured obligations of the Company.

 

The Convertible Senior Notes are convertible into shares of Company’s common stock. As of March 31, 2013 the conversion rate was 122.5638 shares of common stock per $1,000 principal amount of Convertible Senior Notes, which is equivalent to a conversion price of approximately $8.159 per share of common stock. The conversion rate is subject to adjustment upon certain events.

 

Upon conversion, unless a holder converts after a record date for an interest payment but prior to the corresponding interest payment date, the holder will receive a separate cash payment with respect to the Convertible Senior Notes surrendered for conversion representing accrued and unpaid interest to, but not including the conversion date. Any such payment will be made on the settlement date applicable to the relevant conversion on the Convertible Senior Notes.

 

No holder of Convertible Senior Notes will be entitled to receive shares of the Company’s common stock upon conversion to the extent (but only to the extent) that such receipt would cause such converting holder to become, directly or indirectly, a beneficial owner (within the meaning of Section 13(d) of the Securities Exchange Act of 1934 and the rules and regulations promulgated thereunder) of more than 5.0% of the shares of the Company’s common stock outstanding at such time. The 5.0% limitation shall no longer apply following the effective date of any fundamental change. The Company will not issue any shares in connection with the conversion or redemption of the Convertible Senior Notes which would equal or exceed 20% of the shares outstanding at the time of the transaction in accordance with NASDAQ rules. At March 31, 2013, the company was in compliance with all of its debt covenants.

 

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Subject to certain exceptions, holders may require us to repurchase, for cash, all or part of their Convertible Senior Notes upon a fundamental change at a price equal to 100% of the principal amount of the Convertible Senior Notes being repurchased plus any accrued and unpaid interest up to, but excluding, the fundamental change repurchase date. In addition, in the case of certain fundamental changes and without duplication of the foregoing amount, the Company will also pay holders an amount in cash (or, in certain circumstances, shares of the Company’s common stock) equal to the present value of the remaining interest payments on such notes through, and including, the maturity date.

 

In connection with the issuance of the Convertible Senior Notes, the Company incurred approximately $2.4 million of debt offering costs, which are being amortized over the term of the facility on an effective yield method, of which approximately $1.5 million remains to be amortized.

 

The Convertible Senior Notes have been analyzed for any features that would require its accounting to be bifurcated. There are no features that require accounting to be bifurcated, and as a result, they are recorded as a liability at their contractual amounts.

 

Fair Value of Convertible Senior Notes. The Company carries the Convertible Senior Notes at cost. The Convertible Senior Notes were issued in a private placement and there is no active trading of these notes. The fair value of the Company’s outstanding Convertible Senior Notes was approximately $79.8 million at March 31, 2013. The fair value was determined based on the average of indicative bid and offer pricing for the Convertible Senior Notes.

 

Senior Notes

 

On October 10, 2012, the Company issued $41.4 million in aggregate principal amount of unsecured 7.375% Senior Notes due 2019. The net proceeds for the Senior Notes, following underwriting expenses, were approximately $ 39.9 million. Interest on the Senior Notes is paid quarterly in arrears on March 30, June 30, September 30 and December 30, at a rate of 7.375%, commencing December 30, 2012. The Notes mature on September, 30, 2019. The Senior Notes are senior unsecured obligations of the Company. In addition, due to the asset coverage test applicable to us as a BDC and a covenant that we agreed to in connection with the issuance of the Senior Notes, we are limited in our ability to make distributions in certain circumstances. At March 31, 2013, the Company was in compliance with all of its debt covenants.

 

In connection with the issuance of the Senior Notes, the Company incurred approximately $1.5 million of debt offering costs which are being amortized over the term of the facility on an effective yield method, of which approximately $1.4 million remains to be amortized.

 

Fair Value of Senior Notes.  The Senior Notes were issued in a public offering on October 10, 2012. The fair value of the Company’s outstanding Senior Notes was approximately $43 million at March 31, 2013. The fair value was determined based on the average of indicative bid and offer pricing for the Senior Notes.

 

The Facility

 

On February 24, 2012, the Company entered into a Note Purchase Agreement with Credit Suisse AG, Cayman Islands Branch, Credit Suisse Securities (USA) LLC, as arranger, The Bank of New York Mellon Trust Company, National Association, as collateral administrator and collateral agent, and KCAP Funding, a special-purpose bankruptcy remote wholly-owned subsidiary of the Company (“KCAP Funding”), under which the Company may obtain up to $30 million in financing (the “Facility”). The scheduled maturity date for the Facility is December 20, 2014. Interest on the Facility is LIBOR + 300 basis points and payable quarterly.

 

Advances under the Facility are used by the Company primarily to make additional investments. The Facility is secured by loans that it currently owns and a security interest in the Company’s right to receive certain management fees. The Company’s borrowings under the Facility are effectuated through KCAP Funding.

 

As of March 31, 2013, there were no amounts outstanding under the Facility and the Company was in compliance with all of its debt covenants. The average amount outstanding in 2013 under the Facility was $0.

 

In connection with the Facility, the Company incurred approximately $444,000 of debt origination costs which are being amortized over the term of the Facility on a straight-line basis of which approximately $286,000 remains to be amortized.

 

As of March 31, 2013, we had $101.4 million of borrowings outstanding at a weighted average fixed rate of 8.19%.

 

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7. DISTRIBUTABLE TAXABLE INCOME

 

Effective December 11, 2006, the Company elected to be treated as a RIC under the Code and adopted a December 31 calendar year end. As a RIC, the Company is not subject to federal income tax on the portion of its taxable income and gains distributed currently to its stockholders as a dividend. The Company’s quarterly dividends, if any, are determined by the Board of Directors. The Company anticipates distributing at least 90% of its taxable income and gains, within the Subchapter M rules, and thus the Company anticipates that it will not incur any federal or state income tax at the RIC level. As a RIC, the Company is also subject to a federal excise tax based on distributive requirements of its taxable income on a calendar year basis (e.g., calendar year 2013). Depending on the level of taxable income earned in a tax year, the Company may choose to carry forward taxable income in excess of current year distributions into the next tax year and pay a 4% excise tax on such income, to the extent required. The Company anticipates timely distribution of its taxable income within the tax rules, and the Company anticipates that it will not incur a US federal excise tax for the calendar year 2013.

 

The following reconciles net increase in shareholders’ equity resulting from operations to taxable income for the three months ended March 31, 2013:

 

   Three Months Ended
March 31, 2013
 
   (unaudited) 
      
Net increase in net assets resulting from operations  $7,213,281 
Net change in unrealized (appreciation) depreciation from investments   (349,862)
Excess capital losses over capital gains   (82,937)
Income not on GAAP books currently taxable   46,143 
Income not currently taxable   (17,089)
Expenses not currently deductible   5,911 
      
Taxable income before deductions for distributions  $6,815,447 
      
Taxable income before deductions for distributions per weighted average shares for the period  $0.23 

 

For the quarter ended March 31, 2013, the Company declared a dividend on March 15, 2013 of $0.28 per share for a total of approximately $9 million. The record date was April 5, 2013 and the dividend was distributed on April 26, 2013.

 

Taxable income differs from net increase (decrease) in stockholders’ equity resulting from operations primarily due to: (1) unrealized appreciation (depreciation) on investments, as investment gains and losses are not included in taxable income until they are realized; (2) amortization of discount on CLO Fund securities; (3) amortization of organizational costs; (4) non-deductible expenses; (5) stock compensation expense that is not currently deductible for tax purposes; (6) excess of capital losses over capital gains; and (7) recognition of interest income on certain loans.

 

At March 31, 2013, the Company had a net capital loss carryforward of approximately $54 million to offset net capital gains, to the extent provided by federal tax law. The capital loss carryforward will begin to expire in the tax year ending December 31, 2015.

 

The Company adopted Financial Accounting Standards Board ASC Topic 740 Accounting for Uncertainty in Income Taxes (“ASC 740”) as of January 1, 2007. ASC 740 provides guidance for how uncertain tax positions should be recognized, measured, presented, and disclosed in the financial statements. ASC 740 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. The Company recognizes the tax benefits of uncertain tax positions only where the position is “more likely than not” to be sustained assuming examination by tax authorities. Management has analyzed the Company’s tax positions, and has concluded that no liability for unrecognized tax benefits should be recorded related to uncertain tax positions taken on returns filed for open tax years (the last three fiscal years) or expected to be taken in the Company’s current year tax return. The Company identifies its major tax jurisdictions as U.S. Federal and New York State, and the Company is not aware of any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will change materially in the next 12 months. The adoption of ASC 740 did not have an effect on the financial position or results of operations of the Company as there was no liability for unrecognized tax benefits and no change to the beginning capital of the Company. Management’s determinations regarding ASC 740 may be subject to review and adjustment at a later date based upon factors including, but not limited to, an ongoing analysis of tax laws, regulations and interpretations thereof.

 

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8. COMMITMENTS AND CONTINGENCIES

 

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the needs of the Company’s investment in portfolio companies. Such instruments include commitments to extend credit and may involve, in varying degrees, elements of credit risk in excess of amounts recognized on the Company’s balance sheet. Prior to extending such credit, the Company attempts to limit its credit risk by conducting extensive due diligence, obtaining collateral where necessary and negotiating appropriate financial covenants. As of March 31, 2013 and December 31, 2012, the Company committed to make no investments in delayed draw senior secured loans.

 

9. STOCKHOLDERS’ EQUITY

 

During the three months ended March 31, 2013 and the year ended December 31, 2012, the Company issued 23,572 and 76,208 shares, respectively, of common stock under its dividend reinvestment plan. For the three months ended March 31, 2013, the Company issued no shares of restricted stock, no shares were forfeited and no shares of restricted stock were converted to common stock due to vesting. For the year ended December 31, 2012, the Company issued 34,757 shares of restricted stock for which 232,768 shares were forfeited and 97,071 shares vested. The total number of shares of the Company’s common stock issued and outstanding as of March 31, 2013 and December 31, 2012 was 31,936,480 and 26,470,408, respectively.

 

10. EQUITY INCENTIVE PLAN

 

During 2006 and as amended in 2008, the Company established the equity incentive plan, (“the “Plan”) and reserved 2,000,000 shares of common stock for issuance under the Plan. The purpose of the Plan is to provide officers and prospective employees of the Company with additional incentives and align the interests of its employees with those of its shareholders. Options granted under the Plan are exercisable at a price equal to the fair market value (market closing price) of the shares on the day the option is granted. Restricted stock granted under the Plan is granted at a price equal to the fair market value (market closing price) of the shares on the day such restricted stock is granted.

 

Information with respect to options granted, exercised and forfeited under the Plan for the period January 1, 2012 through March 31, 2013 is as follows:

 

   Shares   Weighted Average Exercise Price per Share   Weighted Average Contractual Remaining Term (years)   Aggregate Intrinsic Value1 
Options outstanding at January 1, 2012   60,000   $7.24           
Granted                  
Exercised                  
Forfeited                  
Options outstanding at December 31, 2012   60,000   $7.24    6.5   $172,400 
Granted                  
Exercised   (10,000)              
Forfeited                  
                      
Outstanding at March 31, 2013   50,000   $7.72    6.1   $235,600 
                     
Total vested at March 31, 2013   50,000   $7.72    6.1      

 

1Represents the difference between the market value of shares of the Company upon exercise of the options at March 31, 2013 and the cost for the option holders to exercise the options.

 

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The Company uses a Binary Option Pricing Model (American, call option) to establish the expected value of all stock option grants. For the three months ended March 31, 2013 and 2012, the Company recognized no non-cash compensation expense related to stock options. At March 31, 2013, the Company had no remaining compensation cost related to unvested stock option-based awards.

 

Restricted Stock

 

On June 13, 2008, the Company’s shareholders approved the Plan, as amended, and the Board of Directors approved the grant of awards of 100,250 shares of restricted stock to certain executive officers of the Company. On October 7, 2011 and July 22, 2010, the Board of Directors approved the grant of an additional 86,805 and 103,519 shares of restricted stock, respectively, to a certain executive officer of the Company. Such awards of restricted stock will vest as to 50% of the shares on the third anniversary of the grant date and the remaining 50% of the shares on the fourth anniversary of the grant date.

 

On June 13, 2008, the Company’s Board of Directors authorized the Company to allow employees who agree to cancel options that they hold to receive shares of the Company's common stock to receive 1 share of restricted stock for every 5 options so cancelled. The shares of restricted stock received by employees through any such transaction will vest annually generally over the remaining vesting schedule as was applicable to the cancelled options. Subsequently, employees holding options to purchase 1,295,000 shares individually entered into agreements to cancel such options and to receive 259,000 shares of restricted stock. As of March 31, 2013, 233,998 of such shares were vested and converted to common shares. The remaining 25,002 shares have been forfeited.

 

On June 10, 2011, the Company’s shareholders approved the Amended and Restated Non-Employee Director Plan, and the Board of Directors approved the grant of awards of 4,000 shares of restricted stock to the non-employee directors of the Company as partial annual compensation for their services as director. Such awards of restricted stock will vest as to 50% of the shares on the grant date and the remaining 50% of the shares on the first anniversary of the grant date.

 

During the three months ended March 31, 2013, no shares of restricted stock had vested. As of March 31, 2013, after giving effect to these option cancellations and restricted stock awards, there were options to purchase 50,000 shares of common stock outstanding and there were 32,257 shares of restricted stock outstanding. Information with respect to restricted stock granted, exercised and forfeited under the Plan for the period January 1, 2012 through March 31, 2013 is as follows:

 

   Unvested Restricted Shares   Weighted Average Exercise Price per Share  
Unvested shares outstanding at December 31, 2011   327,339   $6.46 
Granted   34,757   $6.66 
Vested   (97,071)  $9.08 
Forfeited   (232,768)  $5.37 
Unvested shares outstanding at December 31, 2012   32,257   $6.69 
Granted      $ 
Vested      $ 
Forfeited      $ 
Outstanding at March 31, 2013   32,257   $6.69 
           
Total non-vested shares at March 31, 2013      $6.69 

 

For the three months ended March 31, 2013, non-cash compensation expense related to restricted stock was approximately $20,000; of this amount approximately $15,000 was expensed at the Company, and approximately $5,000 was a reimbursable expense allocated to the Asset Manager Affiliates. For the three months ended March 31, 2012, non-cash compensation expense related to restricted stock was approximately $173,000; of this amount approximately $169,000 was expensed at the Company and approximately $4,000 was a reimbursable expense allocated to the Asset Manager Affiliates.

 

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Dividends are paid on all outstanding shares of restricted stock, whether or not vested. In general, shares of unvested restricted stock are forfeited upon the recipient’s termination of employment. As of March 31, 2013, the company had approximately $99,000 of total unrecognized compensation cost related to non-vested share-based awards. That cost is expected to be recognized over a weighted average period of 3.1 years.

 

11. OTHER EMPLOYEE COMPENSATION

 

The Company adopted a 401(k) plan (“401K Plan”) effective January 1, 2007. The Plan is open to all full time employees. The 401K Plan permits an employee to defer a portion of their total annual compensation up to the Internal Revenue Service annual maximum based on age and eligibility. The Company makes contributions to the 401K Plan of up to 2% of the $250,000 maximum eligible compensation, which fully vest at the time of contribution. For the three months ended March 31, 2013 and 2012, the Company made contributions to the 401K Plan of approximately $11,000 and $11,000, respectively.